News that a commercial aircraft was shot down in eastern Ukraine last week left the market in total shock. Three days later, the euro began to slide, gradually falling to an eight-month low. The reasons for its decrease are evident:
- Increased geopolitical risk and the resulting higher energy prices will negatively impact the eurozone more than the U.S., as Europe relies on Russian energy supplies.
- The European Central Bank may be encouraged to take even more precautionary monetary steps for a longer period to avoid further deflationary pressures.
In addition to the euro’s response, money also found a safe-haven in the U.S. dollar and U.S. Treasuries, with the 10-year yield falling below 2.5%. German 10-year yields also reached multi-year lows.
However, the euro’s drop in value is minor compared to the financial loss that the Russian economy has experienced. While Russia continues to disassociate itself from the downing of the Malaysian passenger plane, the financial market has its own view.
After the crash, the Micex Index fell 6.1% over the next three days; credit default swap spreads on Russian sovereign bonds widened by about 200 basis points; and Russia’s credit rating was downgraded to BBB-, just one notch above junk status. Russia canceled its first ruble bond auction in three months because of the surge in the funding cost, which is the highest among the world’s largest emerging markets.
This is all happening in the midst of a record rally in U.S. stocks; lower U.S. long-term interest rates; and a stable currency. It is said that the 19 richest Russians lost $14.5 billion since the beginning of this year, while the 64 richest Americans gained $56.5 billion.
My view: I don’t think that the euro will fall dramatically from here, but ongoing geopolitical risk will keep it under pressure. However, there is a more important lesson here, and that is that empire building can come with a cost, as the global financial market reacts and sends its own message.
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