Hopes for peace but what about sanctions?

Markets reacted strongly yesterday to Russia’s announcement of a significant reduction in military activity in the Kiev region. Many saw this as confirmation of progress in the negotiations and hopes of a ceasefire or even a lasting peace were boosted. European equity markets have now fully recovered their losses since the start of the war, while US markets are approaching their levels of the beginning of the year. The EUR/USD exchange rate has also rebounded sharply, above 1.11.

This seems premature, to say the least, given the situation on the ground in Ukraine where there is no indication that Russia will not launch a new offensive. What would be the gains in relation to the resources deployed that Vladimir Putin could boast of at this stage? And economically, what really matters is the impact of the sanctions and the breakdown of trade relations between Russia and most rich countries, the consequences for raw material supplies, the disruption of industrial supply chains and the build-up of inflationary pressures. All this is likely to continue anyway. It is also surprising that the markets are completely ignoring the signals sent by the yield curve with in particular yesterday’s 10y-2y spread briefly turning negative in the US. One could add to this the expected consequences of the lockdown imposed on Shanghai which weighs nearly 4% of Chinese GDP and weighs twice as much in international trade as Shenzhen, which was also recently put under lock and key to contain the pandemic.

The economic agenda is filled today with a sharp rise in German inflation expected in March, the European Commission survey and ADP estimates of private employment in the US in March.