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Ukraine crisis sets the tone The crisis in Ukraine dominated activity Monday. The dollar gained all around against its G10 counterparts (even JPY) as the US currency’s safe-haven appeal came to the fore amidst general risk aversion. Stocks fell while oil and government bond prices rose. Gold was little changed, however.

Only two of the 15 EM currencies that we track -- RUB and CZK – were noticeably lower vs USD, while several gained substantially, including THB, TRY, IDR and ZAR. This shows there is little if any contagion effect from the Ukraine crisis on other EM markets. The gains of the high-yielding currencies suggest that carry trades are not being affected (yet).

Outlook for the crisis: The latest round of US sanctions against Russia, targeting publicly traded companies, is a clear escalation from previous rounds. While there was some division between the US and Europe on the scale of sanctions last week, the airline tragedy increases the likelihood that Europe will respond with stricter sanctions more in line with those of the US. We await the results of today’s EU foreign ministers’ meeting to see if EU governments will ratchet up their response.

Russian President Putin’s response to these sanctions is key. He has to choose between two unpleasant alternatives: either give up supporting Russian separatists in Ukraine and face a loss of political capital among nationalists at home, or tough it out against ever-tightening sanctions and face decreasing popularity among the general public. Alternatively, he could even escalate the crisis now in order to de-escalate later. His actions will be driven primarily by his desire to maintain his domestic popularity, which he gauges through his popularity ratings. The latest polls suggest that war fatigue may be setting in, with 56% of Russians against sending troops to eastern Ukraine. Such numbers suggest that Putin is likely to prefer to de-escalate the crisis. De-escalation of the crisis would of course cause a reversal of the risk-off pattern.

The UN Security Council yesterday unanimously (i.e., including Russia) adopted an Australia-proposed resolution calling for an independent investigation into the downing of Malaysia Airlines Flight MH17, cessation of military activity around the site and unimpeded access for investigators, AP reported. This response also suggests that Putin may adopt the de-escalation path. On the other hand, there are questions about how much control Russia has over the separatist movement.

On top of the geopolitical excitement in Europe, the Bundesbank monthly report said that “economic growth in Germany markedly lost momentum in the first two months of spring.” Yet after all that, EUR/USD is opening in Europe this morning just 13 pips lower than yesterday’s opening. However, one of the reasons EUR has been so well supported has been US buying of European stocks, but as European markets decline, those flows are likely to reverse, dragging EUR/USD down.

Today’s schedule: The EU foreign ministers’ meeting mentioned above is the main event in Europe. There are no major data due out from the Eurozone today. From the UK, we get the CBI Trends survey for July.

In the US, the CPI for June is anticipated to remain unchanged in pace at +2.1% yoy. Given that US average weekly wages rose by 2.0% yoy in June, this would make a second month in a row that real wages declined. Speaking last week before Congress, Fed Chair Yellen noted that real wage gains “have been nonexistent” (although to be fair, the Fed looks more at the Employment Cost Index, which is growing slightly faster.) She has previously emphasized the potential risks to consumer spending posed by wages rising by less than the rate of inflation.

Existing home sales for June are forecast to rise, but last Thursday’s disappointing housing sector data may push the figure to a weaker level. The Richmond Fed manufacturing index for the same month is expected to decline. The Federal Housing Finance Agency (FHFA) home price index is forecast to show that the pace of increase in house prices slightly accelerated in May.

Overnight, Australia’s Q2 CPI is forecast to have slowed +0.5% qoq, from +0.6% qoq. That could prove negative for AUD.

Tuesday, 22 Jul, 2014 / 11:43

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