At the time of writing this blog, we are still early in the unfolding political drama between Russia and the Ukraine. The markets have taken a bit of a knock as a result. Having read various articles and listened to several calls, let me share a few of the early views that are emerging.
We know that President Putin has sent troops into the Crimean Peninsula. Whether this is to annex Crimea or secure its military assets in the region is really a matter of interpretation, as Russia clearly controls the area. (Russia's Black Sea Fleet operates out of their base in Crimea and about 60% of Crimean population are ethnically Russian). What we do not know is: a) how western leaders will respond and b) what are Putin's intentions and next moves.
Response from the West
All indications point to the West having no appetite to escalate the military conflict. The objective seems to be one of engaging Russia in finding a diplomatic solution. It appears there are no legal or treaty obligations that require either the U.S. or NATO to act. The likelihood of broad-based sanctions backed by the United Nations is not great as Russia has veto power and China is not supportive of it. The U.S. has very little leverage over Russia and needs their cooperation in Iran and Syria and has yet to solidify their position on the issue. Some minor sanctions from U.S. Congress is possible but we expect to hear mainly noise and sabre rattling, especially with the arrival of Secretary of State John Kerry in Kiev. Regarding talks of a boycott of the G8 Summit in Sochi, or expulsion of Russia from the G8, neither will keep Putin awake at night. These threats are symbolic at best.
Putin's next move
This is the more challenging question. What is Putin after? If he is satisfied with securing Russian interests in Crimea, and does not look to invade Ukraine any further, then a diplomatic solution will be easily found. In that case, our sense is that Russia won't annex Crimea, but rather secure their interests and then work to establish a more autonomous but clearly pro-Russian government. In the rest of the Ukraine, they will continue to foment dissent and instability to reduce the likelihood of a pro-west government taking hold. An unstable and dysfunctional Ukraine increases the possibility of re-establishing a more pro-Russian government at some time in the future. The Ukraine remains a critical link in Putin's longer-term view of re-establishing a Russian-centric Eurasian economic zone to rival the European Union.
If Putin does choose to escalate the conflict by pushing overtly into eastern Ukraine, the situation could deteriorate rapidly and require a more significant response from the West. I would guess at this point that this is a step further than Putin would risk. Doing so would entail significant local resistance and casualties on both sides. If he did, it might be a temporary ploy to give him a bargaining chip to negotiate a pullback to just the Crimean peninsula. Now is a critical time in understanding which path the various players will choose. Watch for further updates on our thoughts on the crisis in Ukraine.
For now, markets are reacting to the risks. If they subside, albeit with lots of noise as is the more likely scenario, markets will settle down. In the unlikely event of an escalation into direct conflict, the market correction will continue.