by Bill O’Grady and Kaisa Stucke

[Posted: 9:30 AM EDT] We have been monitoring the situation in Russia since early August.  There have been a number of reports indicating a troop buildup on the Ukrainian border.  There have been unsubstantiated accounts of an attack in Crimea; Russia claims Ukrainian special operations forces attempted an attack, while Ukraine suggests Russian soldiers staged the event.  High-ranking leaders within the Kremlin have been sacked.  Russia is launching airstrikes from Iran.  Russian military activity in support of the Assad regime remains high despite a highly visible withdrawal earlier this year.  Russia is making noise about an oil output freeze and cooperating with OPEC.

What is Putin up to?  Although we will have more to say on this in the coming weeks, here is a brief sketch of what we think is going on:

1. Putin needs economic relief: The most effective way to boost the Russian economy is to lift oil prices. The country has a poor record of compliance with such measures as it tends to free ride these types of deals.  Accordingly, we expect the Kremlin to agree to everything but not actually do much of anything.  The second element involves the sanctions that Europe and the U.S. put in place following Russia’s actions against Ukraine.  Putin has tried to “behave” to get results but hasn’t gotten any help.  It appears he is moving back to saber rattling, which explains the troop movements.
2. Russia needs to control Ukraine: At a minimum, it needs a neutral government in Kiev. The current government leans toward Europe, which is unacceptable for Putin.  At this point, the Russian military is incapable of invading and holding Ukraine.  On the other hand, if current presidential polls in the U.S. are correct, Putin will be facing a more hawkish president next year.  Thus, if Putin wants to aggressively take territory in Ukraine, the window of opportunity is closing.
3. Putin feels insecure: The internal shakeup within the Kremlin suggests Putin is feeling threatened. He recently removed his long-time chief of staff, Sergei Ivanov.  Putin and Ivanov have ties going back to the Soviet Union days; they were both KGB operatives.  We suspect Putin feared his chief of staff was plotting to take power at some point, and so he was removed.  In recent weeks, Putin has also relieved regional officials and managers of state-controlled enterprises.  Parliamentary elections will be held in Russia on September 18.  Putin has generally been able to control the outcomes of polls in Russia but these moves suggest he may be unusually worried about this outcome.

Reuters is reporting this morning that Chancellor Merkel “sees no reason” to lift sanctions against Russia because it hasn’t met the requirements of various treaties.  Although Greece and Italy have hinted they would like to see sanctions relaxed, we doubt anything will happen without German support.  Given the pressures that Putin faces, it is reasonable to expect that he will create more problems.  Just how this friction will affect financial and commodities markets isn’t completely obvious but we suspect Russian actions will be bullish for the dollar, gold and Treasuries.  The impact on oil is mixed.  A stronger dollar is generally bearish for oil, whereas military threats will tend to boost oil prices.  Given the ample level of stockpiles, the dollar effect would probably overwhelm the geopolitical impact.  However, Russia does have an incentive to lift oil prices and working directly with Iran in the Middle East is a major threat to Saudi Arabia.  We will be watching Putin closely in the coming weeks to see how this all unfolds.

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