From Russia, without love

6 min read

If anyone thought that the Russians were going to take Western criticism sitting down, they ought to be caned. First candidate for corporal punishment has to be Australian foreign minister, Julie Bishop, who has referred to the Russian counter-sanctions as “petulant” after Prime Minister Medvedev announced that Russia would be banning the import of beef, pork, fruit, vegetable, poultry, fish and dairy products from the EU, United States, Canada, Australia and Norway.

Please note that the most important of Russian staples, alcohol, is not included.

Soft commodity prices have been pretty volatile this year with wheat leading the way. Markets seem unsure as to whether they should be rallying on the Ukraine crisis or whether it will ultimately not affect supplies. It traded to a high of just under US$750/bushel in early May, only to drop back to US$520/bushel by the end of July. The last week has seen a bounce back and last night it closed at US$561/bushel.

Although grain is not part of Moscow’s sanction package, the rest is all about foodstuffs which will bring with it another headache for the ECB and for Saint Mario who are fighting impending deflation. The last thing they now need to face is a European agro-industry which is long produce and short an outlet. The sanctions could well depress food prices across the eurozone. With CPI running at 0.4%, it won’t take much to push that figure into negative territory. That, if my reading of the situation is correct, is economic warfare of the most elegant kind.

Medvedev is not being in the slightest petulant. He is outsmarting the West in the most subtle of ways. Western political leaders are always playing to the gallery with their grand gestures which is why the Russians persistently appear to be one step ahead of their rivals. They know that they are not playing for matchsticks but that they are playing for money.

King Charles XII of Sweden, Emperor Napoleon Bonaparte of France and Chancellor Adolf Hitler of Germany all underestimated the Russians’ ability to patiently wait and they all three subsequently came horribly unstuck in the process. The West might not be planning to send cavalry, either of the four legged or the armoured variety, into the steppes of Russia but if Moscow makes good on its threat to close the airspace over its vast territory to the West, it will cause untold disruption at virtually no cost to itself. As in 1709, 1812 and 1942, it can use its huge landmass as a weapon against all comers.

There might be no sharp equipment flying around going “bang!” but it seems to me as though battle might very quietly and very gently been joined.

The fallout

Markets are responding in the only way they seem to know with German bonds through the roof. Based on the charts, I forecast on Monday that the 10yr Bund should break through 1.00% in yield at some time between September 21st and October 20th. This morning it opens at 1.025% having rallied 14bp in two days. There is no reason why we shouldn’t have a go at making that last bit in price. The 2yr Schatz is already trading at a negative yield again. This makes 2yr US treasuries at 0.41% and 10yr at 2.35% look like regular little high yielders.

So far I have held the belief that the poor price action we have been seeing in risk assets is no more than a storm in a calm summer tea-cup but yesterday was not pretty. I might have to concede that there could be more to the sell-off than I had been prepared to admit.

The blind buying of risk for risk’s sake had to come to an end at some point and I shall be watching very carefully to see whether this is the inflection point we had been waiting for. More to the point, it will be interesting to see how well all the regulators’ highfalutin risk-immunisation measures serve the innocent investor.

On Alex, democracy and a wee dram

Finally, and somewhat as a non-sequitur, I was thinking about Alex Salmond’s declaration in the televised independence debate with Alistair Darling on Tuesday that he had found himself governed for half his life by a government he had not voted for. I was reflecting on that point and, you know what, so have I. That, Mr Salmond, is what we call democracy. Incidentally, I wonder whether he will pop up and use this exemption of the Scottish national drink and prize Highland export from the sanctions to declare never-ending friendship between the Scottish and the Russian people?

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Alas, it is that time of the week again and all that remains is for me to wish you and yours a happy and peaceful week-end. Normally at this time of year one hopes for an exciting and stimulating week-end in order to make up for a long and event free week in the office. I strongly suspect that this time it will be the other way around.

Anthony Peters