Macro Mondays 🌍: Macro Implications of Ukraine’s Stunning Counteroffensive
🌍 Macro Mondays by Michael 🌍 Monday, September 12th
Europe is in trouble. Along with the European Central Bank’s belatedly hawkish turn, the continent is buckling under the weight of sky-high energy prices. Markets are currently flashing warning signs that Europe will soon face a difficult winter as businesses and consumers alike confront crippling energy prices.
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The European Union has scrambled a response and is set to unveil its plan for an unprecedented intervention into energy markets, aimed at reducing consumption and injecting liquidity into the market to ensure the crisis does not metastasize further.
The elephant in the room is, of course, Russia’s invasion of Ukraine. As the war has dragged on, European countries from England to Poland have upped their commitments to Ukraine, sending weapons and money to push back on Russia’s ruthless revanchism. As Europe’s support has grown more overt, Putin has escalated in desperation — most recently weaponizing Russia’s gas exports to Europe.
Outside of hawkish central bank policy, the European energy crisis is perhaps the biggest macro story of the year. It’s affecting everything from FX to crypto markets, and everything in between. Intimately understanding Europe’s energy puzzle has been every good macro trader’s homework following Russia’s invasion of Ukraine on February 24th.
Since the start of the war, Europe has reduced its reliance on Russian gas through a combination of import substitution and ramping up of alternative energy sources. However, as of today, Europe has exhausted its short-term options. The Eurozone can only make further, more painful cuts to consumption and/or pray for a merciful, warm winter.
There is simply not enough time to reorient entire European economies away from Russian natural gas. And, even if there was, there physically is not enough American LNG capacity or gas from Norway to offset the complete loss of Russian flows.
The latest Wall Street parlor game is focused on whether or not Europe will be able to survive winter without Russian gas. Two camps have formed. The first camp is more pessimistic and believes European populaces will revolt when they cannot heat their homes and power their stoves. This camp expects European countries to eventually wilt under the inevitable domestic turmoil and pressure Kyiv to acquiesce to negotiations and an eventual peace agreement.
This first camp points to unrest, like the events that occurred in Prague last week, which saw 70,000+ people show up to protest their government’s continued support of Ukraine, for which they have paid a steep financial price.
This first camp believes the end game will go something like this: a rattled Europe will swallow its pride and force Kyiv to cut an unfavorable deal with Putin that offers him control over large parts of the Donbas region of Ukraine, as well as Crimea, in exchange for the resumption of Russian gas flows into the European market. From a European perspective, everyone wins! That is, everyone except the Ukrainians…
The second (opposing) camp is slightly more optimistic and believes Europe will brave the winter and remain committed to backing the Ukrainians in what looks to be a prolonged war likely to extend well into 2023. This camp is laser-focused on Ukraine’s recent battlefield success, viewing it as concrete proof that Kyiv can not only blunt the Russian offensive but perhaps even win the war.
Politically, European leaders will have an easier time convincing their respective populations to cope with high energy prices and energy consumption restrictions if their populations truly believe the Ukrainians can win. Everyone wants to be associated with a winner!
So, this makes the on-the-ground situation in Ukraine incredibly important – not just to Russia and Ukraine – but to all of Europe. Against this backdrop, the events of the last few days have been monumental. For some time, Ukraine has been signaling a counteroffensive aimed at recapturing the southern city of Kherson – a major Ukrainian city near the vital port city of Odessa.
The Russians took the bait and shifted resources – men + machines – to the southern front in order to reinforce their Kherson position. Last week, Ukraine began its telegraphed counteroffensive in the south. But in a stunning move, just a few days later, the Ukrainians initiated a separate surprise attack along the northern front, aimed at regaining territory near the Kharkiv region. It now appears the much-publicized Ukrainian southern offensive was a ruse, designed to distract Russia from the real one aimed at the Kharkiv region.
The early results – which we should take with a grain of salt as the fog of war hangs heavy – paint an unmistakably bullish picture for Ukraine.
It appears the Ukrainians have recaptured nearly all of Kharkiv and its surrounding villages and at some points driven the overwhelmed invaders all the way back across the Russian border. There have been reports that entire Russian units are dropping their weapons in retreat and, in some cases, simply surrendering altogether. An absolutely stunning turn of events.
The timing of this counteroffensive is no accident. Kyiv is well aware that Europe faces a challenging winter that will test its resolve. Ukraine likely felt some political pressure to deliver tangible proof that Europe’s support is, indeed, paying dividends on the battlefield.
Many key questions that remain:
How widespread are Russian desertions?
How will Putin react to this shocking setback? Will he escalate?
Will the Ukrainians continue to push forward or pause to regroup?
Will this “win” provide enough political capital for European countries to remain aligned with Kyiv ahead of the coming winter?
What we do know is that Moscow is reeling. Russian commentators are now openly calling for the generals in charge of the Kharkiv area to be executed.
Meanwhile, The Moscow Times is reporting that Putin abruptly canceled a planned meeting with his top military staff after the collapse of the Kharkiv front. Putin has apparently retreated to his Sochi mansion, further isolating himself from the rest of his government. In other news: the Kremlin announces that planned referendums on the annexation of Ukrainian territories have been canceled.
It remains too early to call whether this Ukrainian counteroffensive was merely an isolated victory or a sign of things to come. It’s also too early to make a determination on whether this recent momentum shift will reinvigorate European support. However, we have already seen some early indications that some European countries are encouraged by Ukraine’s success.
At least as of today, it appears that the second camp we spoke of earlier – the one that believes Europe will hold out throughout the winter and stick it to Putin – has the upper hand in the debate. However, things change quickly in war and new facts may emerge over the coming days.
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