By Gregor M.A. Hirt, Global CIO Multi Asset at Allianz Global Investors.
Over the last weekend President Putin’s authority in Russia has been challenged by Yevgeny Prigozhin and his Wagner Group of mercenaries which have previously been loyal to the Russian leader. While both sides took a step back, the situation is a reminder of tensions running within the Russia and important questions over the institutional sustainability of Putin’s regime.
All-in-all the situation remains unclear, with increased probability for extreme outcomes: on the one hand, Russia may be more interested in a negotiated outcome in Ukraine, in order to refocus on domestic issues while looking less resilient to a long-term conflict. On the other hand, there is the risk that Putin feels that he needs a to demonstrate strength and therefore resorts to even more brutal action to “make an example” of Ukraine and the doubters.
What’s the impact for financial markets? For sure, having Prigozhin and a crew of Russian rightwing nationalists seizing power from Putin would certainly have rattled markets substantially.
However, investors have become quite complacent about the situation and potential risks associated with Russia’s war in Ukraine, be it for the gas supply in winter 2024 or lack of agricultural good and fertilizer production in a year of record high temperatures and El Nino phenomenon. Considering the recent environment of very low volatility and renewed warnings by central banks last week that core inflation was still above their targets, it could well be that we start the week on a nervous tone: Investors will analyze the impact of Wagner’s mutiny, start anticipating the next cracks in Putin’s regime and rebalance their geopolitical analysis. Obviously, in such an environment safe havens like gold, the US dollar and US-Treasuries could be the winners while more risky assets could come under pressure.
At this stage, the biggest risk for markets is a rapid uptick of volatility, which on the S&P500 has been at its lowest level since the beginning of January 2020. The recent low levels have allowed more long-term – especially risk-based– investors to re-enter the market. Also, many hedge funds who capitulated on their short positions in the past 2-3 weeks by buying record positions in equities could caught on the wrong foot. Finally, momentum investors who have turned positive on risky assets could be whipsawed by a sharp increase in volatility.
Another asset class to follow closely is oil. The West Texas Intermediate has trended at around USD 70 per barrel, mostly on recession fears – which have yet to materialize– and Russia managing to bring more to the market than expected. Nevertheless, this level does not satisfy Saudi Arabia which has massively intervened on supply by removing volumes corresponding to the entire demand destruction during the Great Financial Crisis 15 years ago, while the US should rebuild its strategic reserves in the coming months – at a time when the driving season is approaching. For oil, any uncertainty related to Russia’s production capacity will clearly be supportive.
Finally, the euro has recently profited from cheap valuation and investors favor to trend toward EURUSD 1.10. However, the Fed’s recent warnings on inflation and solid long positions by investors puts it certainly at risk of short-term weakness, especially as the USD tends to perform well in times of higher volatility. In this regard we maintain a positive stance on the JPY, which also looks attractive valuation having regained some of its safe haven status in light of the recent US banking crisis.
