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EMEA Morning Briefing: Europe on Back Foot Again as Russia-Ukraine Talks End With No Deal

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Opening Call:

Europe's stock markets are likely to extend losses early Tuesday after Ukraine and Russia failed to agree on a cease-fire. In Asia, shares were broadly higher, with the dollar, Treasury yields, oil and gold all booking gains.

Equities:

European shares faced further losses Tuesday as efforts to forge a cease-fire between Russia and Ukraine ended without a deal, though negotiators made some progress. Meanwhile, Russia intensified its attack with a shelling that killed at least 10 civilians.

Ukrainian and Russian negotiators, who met Monday in Belarus, returned to their capitals for consultations and agreed to meet again in the coming days. Both delegations said the five-hour meeting led to some progress.

On Wall Street, Nasdaq eked out a slight gain on Monday, but overall, stocks ended the session lower and booked another month of declines. However, early Tuesday U.S. futures were nudging into positive territory, while most markets in Asia were higher.

"The market is struggling to find a path to optimism, but I think ultimately it will fail," said Phillip Toews, chief executive and lead portfolio manager of Toews Asset Management. "We're on the path toward a broader bear market," he said.

Meanwhile, BlackRock Investment Institute's Wei Li and others said that "we are tactically upgrading equities as we see greater clarity on Ukraine conflict and reduced risk of central banks slamming the brakes to curb inflation."

"We believe market expectations of rate increases have become excessive and have created opportunities in equities," they wrote in a note. "We downgrade credit, preferring to take risk in equities."

Stocks to Watch:

European banks' fundamentals look good, though the geopolitical situation adds uncertainty to their operating outlook, said Morgan Stanley.

It said an expected half-percentage-point increase in eurozone rates should help European lenders' 2023 earnings rise 13% on year, putting them 34% above pre-Covid levels. Their shares look cheap, trading at a discount of about 40% to the market.

Morgan Stanley said the Russia-Ukraine situation could keep shares depressed in the short term and potentially even delay rate hikes. However, "while we continue to monitor risks, the cycle is still benign, and we see attractive upside pricing in rates." Morgan Stanley flagged Intesa Sanpaolo, Caixabank, Commerzbank, SocGen and NatWest as its top picks.

Market Insight:

JPMorgan's market strategists said the worst of the market reaction may be over to the massive sanctions placed on Russia for its assault on Ukraine.

The bank said Monday: "The announced sanctions, though severe, appear to have limited impact on economic growth."

It said that the impact on energy prices so far was "contained" and as a further plus for markets, geopolitical risks may temper some of central banks' more hawkish urges, even with inflation at high levels.

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Salt Funds Management in Auckland said some markets appear to be reacting counter-intuitively to the war since absorbing the initial shock of the invasion.

The new narrative in equity markets is that war could result in less monetary tightening, said managing director, Matt Goodson.

It could be a wrong conclusion, since war is more likely to be an inflationary shock than deflationary, he said. Combined with headwinds for the global economy, the war could create a stagflationary situation of high inflation and low growth that is challenging for stocks.

Economic Insight:

The main impact on the U.K. economy of Russia's invasion of Ukraine is likely to be energy prices staying higher for longer, said Oxford Economics.

But the energy price cap means the pain for consumers will be delayed until October, so Oxford Economics plans a larger cut to its GDP growth forecast in 2023, by 0.5 percentage points, and cut GDP growth by 0.1 percentage points in 2022.

"The prospect of higher inflation will stoke the Monetary Policy Committee's fears that a wage-price spiral will develop," said Oxford Economics.

The additional squeeze on household income also increases the risk of a more abrupt slowdown in activity. Oxford Economics expects two 25 basis points rate hikes this year instead of three.

Forex:

The dollar edged higher in Asia against a basket of currencies, although moves in the currency markets were limited.

On the cease-fire talks, IG said there appears to be some near-term relief as both parties are willing to carry out talks to reach a resolution. However, reservations remain and a wait-and-see sentiment may play out in the coming days as markets await greater clarity.

JPMorgan said the regional effect of the conflict is expected to be differentiated with Europe most affected and a recession increasingly likely in Russia.

"As a share of GDP, trade with Russia is most significant and largest for [central and eastern European] countries, Turkey, and the Euro area." Trade with Russia accounts for only 0.1% of U.S. GDP.

"The regional variation of the potential growth impact will likely bias EUR/USD weaker since the U.S. is expected be more resilient given the progress made in its energy independence and fewer trade linkages."

Bonds:

Treasury yields recovered some of Monday's steep losses as investors paused for breath in Asia.

Florian Spaete, senior bond strategist at Generali Investments said international government bond markets have coped rather well with Russia's invasion of Ukraine, while other assets have been shaken. "This is unlikely to change going forward as fears of higher energy prices are balanced by growth concerns."

Given this view, Generali expects central banks to continue on the rate cycle path mapped out and keeps its 12-month target for core government bond yields, albeit acknowledging increasing downside risks to its forecasts. It continues to forecast the 10-year Bund yield at 0.50% and the 10-year Treasury yield at 2.2% on a 12-month horizon.

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Geopolitical tensions will continue to drive euro corporate bond spreads for now but the longer-term looks brighter, said ING.

However, "there is still reason to be optimistic for credit, and thus, in theory there is significant value being priced into credit" in the long term, said analysts at the bank.

They see technical strength due to a drop in net corporate bond supply and the fact that the European Central Bank is still buying debt until October and thereafter reinvestments will offer some support, while fundamentals are still strong, they say. They see most opportunities in bonds of intermediate maturities and say the short end is now cheap and may outperform on the rebound.

Other News:

On the first day of trading in the wake of massive sanctions on Russia, a Fed tool designed to provide fast liquidity saw no takers.

New York Fed data showed no interest in the central bank's Standing Repo Facility, which offers quick loans collateralized by Treasurys. The tool exists to manage periods of market stress, which reduces the need that Fed officials will have to make active decisions to provide liquidity through repurchase agreement operations.

On Thursday, the Fed will report on foreign demand for dollars via its swap lines, and numbers there could show whether the Russia sanctions are creating issues for the broader financial system.

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Russia-related risks may cause the Federal Reserve's balance sheet to grow before it shrinks, warned Credit Suisse analyst Zoltan Pozsar. That's due to the central bank's currency-swap lines with other nations and the liquidity facility it has with other central banks that allow those institutions to do repos with the central bank as a source of dollar liquidity.

If expansion in the nearly $9 trillion Fed balance happens, it will take place even as the Fed positions itself for what could be an aggressive drawdown of its holdings, as the Fed works to normalize monetary policy.

Energy:

Oil prices continued to rise in the Asian session as supply concerns driven by the ongoing Russia-Ukraine crisis outweigh the possible release by the U.S. and major oil-consuming countries of 70 million barrels of oil from emergency stockpiles.

OANDA said uncertainty over how the Ukraine war will unfold has too many risks that include nuclear threats, which means any dips in oil prices on any strategic release announcement will likely be short-lived.

On Monday, April Brent climbed 3.1% to end above $100 a barrel. The contract, which expired at the end of the session, settled at its highest since September 2014, posting a gain of 10.7% for the month. The more actively traded May contract jumped 4.1% to just under $98.

"Geopolitical risks will remain high for some time," Matthew Parry, head of long-term analysis at Energy Aspects, recently told MarketWatch. "Western sanctions are expanding as the conflict widens." Parry expects Brent to average $101 this year.

Metals:

Gold futures extended gains beyond the $1,900 level in Asia

"If there is no de-escalation between the West and Russia, there will be a surge of physical investment demand into precious metals as a rush into precious safe havens explodes," said Peter Spina, president and chief executive officer at GoldSeek.com, noting that Russia is also among the world's biggest gold producers.

Still, gold prices may see "some selling pressures from some liquidity needs, so you will see some volatility," Spina told MarketWatch. "It is difficult to trade this market in the short term," but investors buying with a "longer-term focus will do quite well."

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March 01, 2022 00:46 ET (05:46 GMT)

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