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S&P 500 rallies as Fed tightens
Stocks rallied, with the S&P 500 recovering above thew former primary support level at 4300. Follow-through above 4400 would be a short-term bull signal.
Markets were lifted by reports of progress on a Russia-Ukraine peace agreement — although that is unlikely to affect sanctions on Russia this year — while the Fed went ahead with “the most publicized quarter point rate hike in world history” according to Julian Brigden at MI2 Partners.
FOMC
The Federal Reserve on Wednesday approved its first interest rate increase in more than three years, an incremental salvo to address spiraling inflation without torpedoing economic growth. After keeping its benchmark interest rate anchored near zero since the beginning of the Covid pandemic, the policymaking Federal Open Market Committee (FOMC) said it will raise rates by a quarter percentage point, or 25 basis points….. Fed officials indicated the rate increases will come with slower economic growth this year. Along with the rate hikes, the committee also penciled in increases at each of the six remaining meetings this year, pointing to a consensus funds rate of 1.9% by year’s end. (CNBC)
Rate hikes are likely to continue at every meeting until the economy slows or the Fed breaks something — which is quite likely. To say the plumbing of the global financial system is complicated would be an understatement and we are already seeing reports of yield curves misbehaving (a negative yield curve warns of recession).
Federal Reserve policymakers have made “excellent progress” on their plan for reducing the central bank’s nearly $9 trillion balance sheet, and could finalize details at their next policy meeting in May, Fed Chair Jerome Powell said on Wednesday. Overall, he said, the plan will look “familiar” to when the Fed last reduced bond holdings between 2017 and 2019, “but it will be faster than the last time, and of course it’s much sooner in the cycle than last time.” (Reuters)
The last time the Fed tried to shrink its balance sheet, between 2017 and 2019, it caused repo rates (SOFR) to explode in September 2019. The Fed was panicked into lending in the repo market and restarting QE, ending their QT experiment.
QT
Equities are unlikely to be fazed by initial rate hikes but markets are highly sensitive to liquidity. A decline in the Fed’s balance sheet would be mirrored by a fall in M2 money supply.
And a similar decline in stocks.
Ukraine & Russia
Unfortunately, Ukrainian and French officials poured cold water on prospects of an early ceasefire.
Conclusion
Financial markets were correct not be alarmed by the prospect of Fed rate hikes. The real interest rate remains deeply negative. But commencement of quantitative tightening (QT) in May is likely to drain liquidity, causing stocks to decline.
Relief over prospects of a Russia-Ukraine ceasefire and/or any reductions in sanctions is premature.
The bear market is likely to continue.
Putin declares war on Europe
Vladimir Putin’s invasion of Ukraine is an effective declaration of war against Europe.
This will no more stop at Kyiv than Hitler stopped at the Sudetenland.
Tragic sites of refugees fleeing Russian bombing and helicopter-borne invasion forces occupying Hostomel Airport military airfield, 15 minutes outside the capital.
All of this could have been avoided if the West had shown more resolve.
Kicking the can down the road
The West has been kicking the can down the road for the past 15 years hoping that the problem would go away. Ever since Vladimir Putin laid out his agenda at the Munich security conference in 2007, the West has tried to buy him off with reset buttons and lucrative gas contracts, looking the other way as he embarked on his expansionist plans, starting with invasion of Georgia the following year.
From Ambassador Daniel Fried and Kurt Volker in Politico, seven days ago:
What is more surprising is how the U.S. and Europe, despite Putin’s obvious warning in Munich and Russia’s many actions over 15 years, have nonetheless clung to the notion that we can somehow work together with Putin’s Russia on a strategic level. It is finally time for the West to face facts. Whether or not Putin launches a major new invasion of Ukraine, he has rejected the post-Cold War European security architecture and means it. He is on a deliberate and dedicated path to build a greater Russia, an empire where the Soviet Union once stood…..
Following the speech, Putin matched his words with actions, dismantling the structures designed to keep peace in post-Cold War Europe. Russia formally announced in July 2007 that it would no longer adhere to the Conventional Armed Forces in Europe Treaty. It continued to reject the principle of host-nation consent for its troop presence in Georgia and Moldova, and began ignoring Vienna Convention limits on troop concentrations, exercises and transparency.
Judge a tree by the fruit it bears
Europe continued to build a trade relationship with Russia, in the hope that prosperity would mellow Putin. Instead the Kremlin used its oil and gas profits to rearm and modernize its military while cracking down on political opposition and a free press. Deaths of journalists and opposition politicians climbed. Eastern NATO leaders who repeatedly warned the West about the need to confront Russia were dismissed as “warmongers”.
By this stage, the Kremlin had even taken its war against opposition figures abroad, with the murder of Alexander Litvinenko in 2006.
In 1998, Litvinenko and several other FSB officers had publicly accused their superiors of ordering the assassination of the Russian oligarch Boris Berezovsky. Litvinenko was arrested the following year but acquitted before being re-arrested. The charges were again dismissed and Litvinenko fled with his family to London where they were granted asylum in the UK. He later wrote two books accusing the Russian secret services of staging the Russian apartment bombings in 1999 and other acts of terrorism in an effort to bring Putin to power. He also accused Putin of ordering the assassination of the Russian journalist Anna Politkovskaya in 2006. Litvinenko died of polonium-210 poisoning that same year, in London.
A UK public inquiry concluded in 2016 that Litvinenko’s murder was carried out by the two suspects and that they were “probably” acting under the direction of the FSB and with the approval of president Vladimir Putin and then FSB director Nikolai Patrushev.
The Obama Reset
On his election in 2009, Barack Obama sought to reset the relationship with Russia, as if the West was to blame for:
- the attempted assassination of Ukrainian president Viktor Yushchenko during his 2004 election campaign — he was poisoned with a potent dioxin that disfigured him but later made a full recovery;
- widespread denial-of-service cyber attacks on Estonia in 2007; and
- invasion of Georgia in 2008.
The reset failed badly, with Russia annexing Crimea and invading the Donbas in 2014. Next was Syria in 2015. Responses by the West, including limited sanctions, proved ineffective.
The Salisbury poisonings
In 2018, Russia was the first state to employ chemical weapons against private citizens in a foreign country. In Salisbury, England, Sergei Skripal and his daughter Yulia, a Russian citizen, visiting him from Moscow, were poisoned with a Russian-developed Novichok nerve agent and admitted to hospital in a critical condition. UK Prime Minister Theresa May accused Russia of responsibility for the incident and announced the expulsion of 23 Russian diplomats in retaliation. A former Russian intelligence officer, Skripal had settled in the UK in 2010 after his conviction on espionage charges in Russia before being exchanged in a spy swap. Both Skripal and his daughter eventually recovered. Moscow refused to cooperate in the interrogation of the two prime suspects, identified by Bellingcat as Alexander Mishkin, a trained military doctor, working for the GRU, and decorated GRU Colonel Anatoliy Chepiga.
Conclusion
The signs have been evident for a long time but were largely ignored.
This was always going to end badly. The longer that the West delays, the worse the eventual toll in lives and human suffering.
Former Swedish PM Carl Bildt sums up the situation:
The Putin invasion of Ukraine that we now see unfolding is the worst outbreak of war that we have had since Hitler invaded Poland in September of 1939. The same motives, the same techniques, the same lies leading up to it. What will happen now remains to be seen. Sanctions will have to be imposed, although that particular deterrence has obviously failed, but it was good to try. We must help the fight in Ukraine. We must treat the Putin regime in the way that it deserves, in all respects. We are heading for bleak days when it comes to the security of Europe. Transatlantic security will be absolutely key.
Never waste a good crisis
The Russian Federation has amassed a large army on the border of Ukraine and threatens to invade unless the US and NATO make concessions including the withdrawal of forces from Eastern Europe, securing Moscow a broad sphere of influence. There has been much hand-wringing in Western media: will Putin invade or is this just a ruse designed to extract concessions?
If we look past the uncertainty, it is clear that an increasingly over-confident Putin has entered a trap of his own making.
The West is faced with an ultimatum: either concede or Russian forces will invade Ukraine.
But every problem presents an opportunity.
The more aggressive Russia becomes, the stronger NATO gets.
Russian actions have united Western alliances, with even long-term neutrals Finland and Sweden, moving closer to NATO. Both Finnish and Swedish presidents reiterated their right to join NATO in response to the Russian ultimatum.
Germany has long obstructed a stiffening of NATO defenses, increasing its vulnerability to Russian energy blackmail by shuttering nuclear power plants and supporting the Nordstream 2 gas pipeline across the Baltic Sea. But opposition is growing. A recent poll shows that the percentage of Germans who trust Russia has fallen by 11% over the past two years:
Concessions are unlikely, simply because there is nothing to gain from them. Concessions by the US would weaken NATO and encourage the Kremlin to make even more outlandish demands in the future. Concessions by NATO without the US would produce a similar outcome.
Russian invasion of Ukraine would be a strategic mistake.
First, invasion would be a flagrant act of war, removing the cloak of deniability that has covered Russian operations in the Donbas region. A formal state of war would increase the flow of Western technology and weapons into Ukraine as Western leaders are required to openly acknowledge Russian aggression.
Land invasions are costly in terms of both blood and treasure. The Russian army may eventually overrun the Ukrainians through the weight of forces and technological advantages. But Ukrainian armed forces have been in a protracted war in the East and are well-trained and equipped with modern anti-tank weapons, artillery and unmanned drones. The costs would be high.
Turkey’s Bayraktar Unmanned Armed Combat Drone – Source: Ukrinform
Where the Ukrainians are at a disadvantage is in air defenses and vulnerability to long-range missile attacks. But that window is closing.
To stiffen Ukraine’s ability to resist, the United States and NATO have dispatched teams in recent weeks to survey air defenses, logistics, communications and other essentials. The United States likely has also bolstered Ukraine’s defenses against Russian cyberattacks and electronic warfare. (David Ignatius, Washington Post)
An air campaign would also achieve little without a follow-up land invasion.
Even if the Ukrainian forces are defeated, that is where the real problem starts. Occupation is a costly and morale-sapping exercise as the Soviets discovered in Afghanistan in the 1980s and the US discovered in Vietnam, Iraq and Afghanistan (they’re slow learners). An insurgency negates the occupiers’ advantages in air power and technology, leading to a drawn-out campaign with no outcome.
“You have the watches. We have the time.” ~ Taliban fighters in Afghanistan.
A Russian occupation force would require 20 combatants for every 1,000 Ukrainians, according to a formula devised by Rand Corp. analyst James Quinlivan in 1995. That would translate into an a required Russian force of almost 900,000, illustrating the impracticality.
We could expect a Russian occupation to be exceedingly brutal, along the lines of Syria, creating a humanitarian crisis and flooding the West with refugees. But that is only likely to harden resolve, marginalizing appeasers in the West, and increase support for the insurgents.
The cost of an extended Russian campaign would deplete the Russian Treasury, even without increased sanctions. It would also escalate opposition within Russia, spurred by the high cost in lives and deteriorating living conditions. The result would threaten collapse of the Russian state in much the same way as the campaign in Afghanistan led to the eventual disintegration of the Soviet Union.
Conclusion
The threat of armed invasion of Ukraine is a mistake. It is likely to strengthen resolve in the West and, if the threat is carried out, result in a long, protracted war in Ukraine. The cost in both blood and treasure would threaten to topple the Russian state.
Russian overconfidence has led them into a trap. Thinly spread across a number of conflict zones, they are vulnerable to an escalation in insurgencies wherever they have “peace-keeping” occupation forces: Syria, Belarus, Ukraine, Moldova, Georgia, and now Kazakhstan. The cost to the West would be low but would exact a huge toll on the Kremlin, depleting their military and already-vulnerable financial resources.
“Moderation in the pursuit of liberty is no virtue.”
~ Charlie Wilson’s War: The Extraordinary Story of How the Wildest Man in Congress and a Rogue CIA Agent Changed History
Airport Donetsk: There are no victors in war
A surprisingly even-handed documentary of the battle for Donetsk Airport. The overwhelming hardship and sacrifice endured by both sides merely underlines this stark message:
There are no victors in this conflict. Only victims.
The war should not have happened. It was instigated by a cynical politician 1000 kilometers away (in Moscow) to stoke nationalist fervor and shore up dwindling public support. His callous disregard for the sacrifice of Russian and Ukrainian lives, and the economic hardship endured by his fellow citizens — a price he considers worth paying to extend his presidency — highlights what the world faces.
He considers the West weak and vacillating. The sooner we face down this threat, the safer our world will be. These words from William Shakespeare (King John, Act 5, Scene 1) still apply today:
Be great in act, as you have been in thought;
Let not the world see fear and sad distrust
Govern the motion of a kingly eye:
Be stirring as the time; be fire with fire;
Threaten the threatener and outface the brow
Of bragging horror: so shall inferior eyes,
That borrow their behaviors from the great,
Grow great by your example and put on
The dauntless spirit of resolution.
….What, shall they seek the lion in his den,
And fright him there? and make him tremble there?
O, let it not be said: forage, and run
To meet displeasure farther from the doors,
And grapple with him ere he comes so nigh.
Putin’s Crimean gamble: Russia, Ukraine, and the new Cold War
From the Brookings Institute:
Since the time of Catherine the Great, Crimea has been a global tinderbox. Most recently, the world was stunned when the forces of Russian President Vladimir Putin invaded and seized Crimea in March 2014. In the months since, Putin’s actions in Crimea, eastern Ukraine and, more recently, in Syria have provoked a sharp deterioration in East-West relations. Basic questions have been raised about Putin’s provocative policies, his motivations, and the future of U.S.-Russian relations—and whether the world has now entered a new Cold War.
On October 26, the Foreign Policy program at Brookings hosted Nonresident Senior Fellow Marvin Kalb for the launch of his new book, “Imperial Gamble: Putin, Ukraine, and the New Cold War” (Brookings Institution Press, 2015). In “Imperial Gamble,” Kalb examines Putin’s actions in Ukraine, the impact on East-West relations, and how the future of the post-Cold War world hangs on the controversial decisions of one reckless autocrat, Vladimir Putin.
Joining the discussion were Thomas Friedman, The New York Times columnist, and Nina Khrushcheva, professor of international relations at The New School. Brookings President Strobe Talbott provided introductory remarks, and Martin Indyk, Brookings executive vice president, moderated the discussion.
Window on Eurasia: Kyiv Must Work to Isolate Moscow Rather than Negotiate with It
From Paul Goble:
Staunton, August 11 – Up to now, Ukraine has made “a serious error” by trying to negotiate with Russia about the Donbas, Bogdan Yeremenko [former Ukrainian diplomat] says. What it should be doing is devoting all its efforts to isolating Russia internationally. That will have far more impact on Moscow’s behavior than any talks Ukraine might have with it……
Up to now, Russia has acted more effectively than Ukraine by “imposing its will and taking the initiative both on the battlefield and at the negotiating table.” Ukraine in contrast “has held fast to a disastrous strategy responding with diplomacy to armed aggression and reducing the opportunities of its own Armed Forces.”
“…..Diplomatic efforts ought to be concentrated not on talks with Russia but on the creation for it of an uncomfortable foreign policy environment and the resolution of practical issues of securing the defense capacity of the country.”
Read more at Window on Eurasia — New Series: Kyiv Must Work to Isolate Moscow Rather than Negotiate with It, Yeremenko Says.
The Long War [podcast]
Excellent insight into the long-term implications of conflict between Russia and the West. Hosted by Brian Whitmore (RFE/Power Vertical) and co-host Mark Galeotti, New York University professor and expert on Russia's security services, with guest James Sherr, an associate fellow with Chatham House's Russia and Eurasia program.
Podcast: The Long War
It's going to be a protracted conflict and Ukraine is just the first major battle.
It's going to be fought in different ways and on multiple fronts: on NATO's eastern frontier; over the countries of former Soviet Union, in the energy market, over the airwaves, and in cyberspace.
We should have no illusions. The West's conflict with Russia is not going away anytime soon, regardless of how the current standoff in Ukraine is resolved.
And what is at stake is nothing short of the future of the international order.
This ain't no Cold War. Russia isn't strong enough for that.
But according to The Russia Challenge, a widely read and highly influential report issued by Chatham House last week, it is shaping up to be a Long War. A protracted looking-glass conflict with a weakening, but still very dangerous, Russia.
On the latest Power Vertical Podcast, we discuss the new Chatham House report and its recommendations.
The panel make some important points:
- The post-Soviet transition to a modern democracy was poorly handled by the West and left Russians with a deep distrust of their motives.
- The most important response to asymmetric warfare is good governance. The last 15 years shows a series of unmitigated blunders that would leave an independent observer with serious questions as to the competence of Western democracies. The West, Ukraine and Baltic States all need to get their house in order.
- Conventional weapons are important, but the primary response should focus on improved intelligence and policing.
Russia terror alert | Kyiv Post
Kyiv Post quotes Markian Lubkivskyi, an adviser to SBU head Valentyn Nailyvaichenko on the rise of terrorism outside of Eastern Ukraine:
“(Terrorists) are aiming to undermine Ukraine from within,” Lubkivskyi told the Kyiv Post, adding that terrorism is one of Russia’s tools in the war against Ukraine. “This is definitely a planned set of linked actions carried out to demoralize people, scare them, spread chaos and create protest moods.”
One of the latest incidents occurred on Jan. 20, when a bridge near the village of Kuznetsivka in Zaporizhzhia Oblast collapsed under a cargo train that was carrying iron ore to Volnovakha in Donetsk Oblast. As a result, 10 cars derailed.
This was the fourth railway explosion over the last two months.
In January, three fuel tanks on a freight train were set on fire at the Shebelynka station in Kharkiv Oblast, and a bomb blew up a freight tank with petrochemicals at the Odesa-Peresyp railway station. On Dec. 24, explosives hidden under the railways hit a train at the Zastava 1 railway station, also based in Odesa.
Odesa has become the main target of attacks in the last two months.
The word terrorism is widely misused. What we are dealing with is state-sponsored terrorism or war by proxy. Without state sponsorship — in the form of training, weapons, logistics and financial support — most terrorist organizations would shrivel up and die. The level of proxy warfare increased hugely since World War II, when direct confrontation between major powers became dangerous because of the advent of nuclear weapons. Instead of direct confrontation these powers resorted to deniable aggression, by proxy, in order to weaken their enemies. The former Soviet Union was a major sponsor of proxy wars, from Korea and Vietnam to support for guerrilla wars elsewhere in Asia, Africa and South America. It appears that Vladimir Putin has adopted a similar strategy and is expanding its use into Eastern Europe.
It is difficult to win a guerrilla war where there are few conventional battles. The lesson from Vietnam is that you can win every battle, but still lose the war. Far better to identify and attack the sponsor through unconventional (asymmetric) means such as sanctions. Make sure that the cost outweighs the benefits of proxy warfare.
When we read the word “terrorism” in popular media, our first question should be: who is the sponsor and how can we make them desist?
Read more at Russia terror alert.
Fascism, Russia, and Ukraine by Timothy Snyder | The New York Review of Books
Yale University’s Timothy Snyder, a leading historian on Eastern Europe, discusses the Russian media claim that the Ukrainian government are fascist:
The strange thing about the claim from Moscow is the political ideology of those who make it. The Eurasian Union is the enemy of the European Union, not just in strategy but in ideology. The European Union is based on a historical lesson: that the wars of the twentieth century were based on false and dangerous ideas, National Socialism and Stalinism, which must be rejected and indeed overcome in a system guaranteeing free markets, free movement of people, and the welfare state. Eurasianism, by contrast, is presented by its advocates as the opposite of liberal democracy.
The Eurasian ideology draws an entirely different lesson from the twentieth century. Founded around 2001 by the Russian political scientist Aleksandr Dugin, it proposes the realization of National Bolshevism. Rather than rejecting totalitarian ideologies, Eurasianism calls upon politicians of the twenty-first century to draw what is useful from both fascism and Stalinism. Dugin’s major work, The Foundations of Geopolitics, published in 1997, follows closely the ideas of Carl Schmitt, the leading Nazi political theorist. Eurasianism is not only the ideological source of the Eurasian Union, it is also the creed of a number of people in the Putin administration, and the moving force of a rather active far-right Russian youth movement. For years Dugin has openly supported the division and colonization of Ukraine.
Read more at Fascism, Russia, and Ukraine by Timothy Snyder | The New York Review of Books.