Macro: The Bottom Line (2/24/2014)

The curious market indifference toward Ukraine

 

If you feel as though an eerie calm has enveloped the global financial markets over the past couple of weeks, you're not the only one. Bonds and currencies have done little more than trend sideways, while stocks more or less regained the ground they lost during January's emerging markets scare. What makes this market tranquility all the more surprising is what's been happening on the news front: an ongoing string of lackluster US economic data (ranging from retail sales and employment to factory orders, all still blamed on the weather), renewed signs of a Chinese manufacturing slowdown, and ... Ukraine.

I'd like to focus on the latter for this week's edition of Macro: The Bottom Line. Now, for those who've been with us for a while, you've probably noticed that we haven't talked much about Ukraine at all - for the precise reason that the investment implications have been de minimis. But given the dramatic developments of the past week, we think it merits a quick discussion nonetheless.

A quick primer for those who are unfamiliar: Ukraine, an Eastern European nation of 46 million people, had been gripped by anti-government protests since November. The initial spark was a decision by the country's pro-Russian president, Viktor Yanukovich, to scrap a trade agreement with the European Union, which many Ukrainians saw as the first step to closer integration with the West, and in turn, to better living standards. To make matters worse, Yanukovich opted instead for a $15bn Russian aid package, firmly aligning Ukraine's economic fate with the whims of the Kremlin. Last week, the protests reached dramatic proportions, when Yanukovich's security forces attempted to storm the protestors' camps in the capital Kiev, leading to violence that killed over 70 people. Just when the country appeared to be on the brink of civil war, however, Yanukovich fled the capital and was subsequently stripped of his powers by parliament, effectively handing the protestors a swift victory. In fact, the protestors' key demands - a new interim government and early elections - have now been granted.

Quite some drama indeed. So why did markets simply shrug it off? There are a number of possible explanations.

 

First, to put it bluntly, Ukraine is simply too insignificant from an economic standpoint. To give you an idea: years of political turbulence and fiscal mismanagement have meant that the country's economy has wilted since the collapse of the Soviet Union. Today, its economy is smaller than that of Greece (that's right, Greece!), even though its population is four times as large. At a time when the markets already have their hands full with the bigger emerging markets (China, Brazil, Turkey etc.), Ukraine ranks rather low on the priority list.

Second, the geopolitical implications of the political tension in Ukraine are rather limited. In the previous decade, when commodity prices were soaring, and when Western Europe had fewer alternatives to Russian gas supplies (piped through countries like Ukraine), Vladimir Putin's maneuvering in Eastern Europe was closely scrutinized, for good reason. Today's world is much different. The fracking boom has already made inroads into the UK and Poland, allowing Europe to diversify its energy needs away from Russia toward "friendlier" sources. And with the Russian economy growing at little more than 1% (unlike the brisk 5%+ pace in the last decade), Putin has lost much in terms of economic leverage. So those still hoping for a grand showdown between Russia and the West in Ukraine will be disappointed.

 

The bottom line: don't let the media hype over the "Ukrainian spring" get to you. Markets have done little more than yawn at the events in Kiev, and it's hard to blame them.