Ukraine and especially the Crimea is in the news (duh), and there is a ton of macro bs going around (as Nassim Taleb would call it). Its doubtful whether most Americans could locate the Crimea on a map, or even the entire country of the Ukraine. Anyway, I hope to have time to write a post on this topic which offers a bit more of a balanced view. I am by no means an expert on Ukraine, but I have extensive knowledge of WWII (Ukraine was a big battlefield), Soviet History (Russia occupied Ukraine and caused a huge famine there), plus I follow the news and have close family from current day Belarus, Russia, Lithuania, Ukraine, Poland etc (the borders change pretty frequently).
I will say in this partial post that there is a reason that Western Ukraine is where the ‘nationalists’ are located, and the history of that is not for the weak of stomach. Ditto for Eastern Ukraine and the Crimea. These actions changed the demographics of both regions. While the Russian actions are discussed slightly, I have seen ZERO coverage of the actions of Ukrainian ethnic cleansing the Western regions (Galicia) in the 1940s; Poles and Jews can tell you about it. I digress..
If I do not get time to write I will say this. RT is totally biased and presents one sided (Russian) perspective. One would think after the terrible job by media of the Egyptian uprising in 2011 the Western media would have learned something. Unfortunately, it seems as if nothing has changed, and the Western media might be doing an even more one sided (pro Ukrainian ‘nationalists’) than we experienced during the Qatari Winter. Therefore, if you want a balanced perspective follow RT AND any major Western media outlet, since both are on total opposite ends you will get a better understanding of the Ukraine.
Events are happening quickly, John Kerry compared Russian actions to those of a 19th century country. He seems to lack basic knowledge of the region since the USSR invasion of Poland, Baltic states and Finland in 1939 and 1940 would have been a better and more recent comparison. Ukraine is mobilizing its army, while the PM warns of a ‘disaster’. I digress… Below are some points from the sell side as of Friday, if I get time I will do a longer post on the topic. You can follow me on Twitter for an uncensored look at my views on Ukraine, Russia and the conflict.
Why Ukraine matters more than you think via Citi Credit Research
“Only wimps pay their debts”
They have some colourful proverbs in Ukraine. We fear that EM bond investors may yet become familiar with more of them in coming weeks. For DM, even a serious deterioration in the Ukraine still feels unlikely to really derail the serene march tighter we saw in spreads again this week – but even so, we think there are some broader implications of the EM woes which investors would do well to be aware of.
“Drunkards know no danger”
In some ways, the lack of market reaction to the Ukrainian revolution is entirely understandable. Sovereign debt is small (40% of GDP, and only 20% external) – so if there is a crisis, it ought to be one of liquidity, not solvency. EM investors have long thought of the Ukraine as a potential trouble-spot, typically categorizing it with Argentina and Venezuela – so their individual exposures ought to be quite manageable. Besides, it only amounts to around 3% of EM bond indices. And spreads are already high, and the curve inverted, meaning shorts are expensive and at first sight a lot is priced in already.
Dig deeper, though, and we are not nearly so sure – both on the Ukraine itself, and on the broader implications.
The markets seem to be making two main attempts to justify bond prices still trading in the low 90s. The first is that ‘surely the EU and US would not remove their support and leave the country to its fate: one way or another, an IMF bailout has to be forthcoming’. The second is that even in a disaster scenario, long-term average EM recovery rates are around 60%. To us, both lines of reasoning seem flawed.
For an example of a country where an uprising that initially looked set to bring democratic and state reforms has been followed by that country being abandoned to its fate, with disastrous humanitarian consequences, you only need to look as far as Syria. Perhaps in the Ukraine it might be slightly clearer to the EU/US which side ‘merits’ their support, but it is not at all difficult to imagine a scenario in which they fail to win power, or – worse – there is no clear government with whom to negotiate.
At a minimum, the country’s first large bond maturity in June makes the timing of the planned elections in late May extremely awkward. On balance, our economist Ivan Tchakarov thinks that provided there is a government in place, the IMF will end up disbursing. Probably this would come in the form of one small ($2bn?) tranche prior to the elections with the promise of a much larger sum afterwards.1
But the probability he attaches to this happening is only slightly better than 50%2 (around 60:40). And it is in the alternative scenario that we come to the second flaw in consensus reasoning.
JPMorgan Russian Equity Research on the Ukraine
We had the first presentation from a new CEO (Ben van Beurden, RD Shell) and (albeit as flagged) a successful $5bn resolution to a major expropriation event that occurred less than 2-years ago (Repsol/YPF, Argentina). Unusually cold weather has driven the US gas price from $3.5 at end October to a high of $6.15/mmbtu (19 Feb) from which it promptly retraced below $5/mmbtu. The cold weather and continued civil unrest (Libya, South Sudan) has supported the oil price with Brent (WTI) YTD averaging $108 ($97) per barrel. We have yet to see a price ripple through European gas markets following events in the Ukraine, but it is early days with Russia yet to play its hand. This could tighten the Atlantic Basin LNG supply picture. Provided refining margins don’t collapse (so far most regions show a modest improvement on Q4 2012), Q1 2014 earnings could be quite respectable. But please don’t get too excited just yet – things are never as good as they look and, although earnings matter, investor focus remains capital restraint and free cash flow visibility and returns.
