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Research Russia: Hope Dies last – Nervous Markets are Far from Pricing in a Full-Blown War

  • Diplomatic stalemate between Russia and the West remains. Military escalation has already started in Eastern Ukraine and, according to US intelligence, Russia has the readiness for an imminent large-scale attack on Ukraine.
  • On Monday evening, Putin announced he will sign the decree for recognizing separatist Luhansk and Donetsk People’s Republics in Eastern Ukraine – a move previously indicated as a potential deal-breaker for diplomacy by the West.
  • Considering military escalation in Eastern Ukraine has started, markets remain surprisingly calm with negative reactions thus far contained to RUB-linked assets.
  • Compared to the situation in January, we now see a diminishing probability for a peaceful solution and raise our estimate of a probability for a full-blown war. The latter would trigger a substantial fall in RUB, weaker EUR and weaker Scandies. Safe-haven assets would benefit, while rising uncertainty would hit stock markets.

The threat of war is rising but diplomacy is still alive

Last week, Russia published its response to the US/NATO proposal that addressed the security guarantees presented by Russia in December. The stalemate continues: Russia was unsatisfied with the US/NATO response which unsurprisingly rejected Russian demands to halt NATO’s expansion to the east and a major rollback of the alliance’s presence in its current eastern member states. The US/NATO insist on maintaining the ‘open-door’ policy, while Kremlin repeatedly calls it their key priority. While the Russian response does not raise high hopes for a diplomatic solution, Russia has not fully closed the door for further diplomatic talks regarding other issues such as arms control and military exercises.

The two sides publicly disagree on a number of other issues regarding the current state of affairs. The US has announced, based on intelligence, that Russia has the readiness to launch a large-scale attack on Ukraine any time now. Media reports have indicated that Putin may have already made the decision to invade. Meanwhile, Russia insists they are not planning to attack and accuse the West of constant provocation. Russian reports that they have been withdrawing troops from the vicinity of Ukraine since last week have been disputed by the West. On the contrary, US and NATO report that Russian buildup of troops (now accumulating to more than 150,000) and artillery at the Ukraine border has continued.

Military escalation in Eastern Ukraine is already happening. Since last Thursday, we have witnessed a number of reports on shelling incidents and ceasefire violations along the line of contact between Ukraine and separatist-held regions. Based on media reports, the security situation in Eastern Ukraine is getting worse by day and for example water supplies have been cut off in some areas.

Full report in PDF.

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