Weekly focus: Geopolitics back on the radar

Rising tensions between Russia and Ukraine caused renewed unease in the markets this week. Putin signed an amendment to Russian nuclear doctrine, which allows Russia to use nuclear weapons for retaliating against strikes carried out with conventional weapons, if they were supported by a nuclear state. The change was an obvious response to US allowing Ukraine to use long-range ATACMS-missiles for strikes within Russian territory. Ukraine swiftly performed its first missile strikes to Russia using American and British weapons starting Tuesday, and on Thursday, Russia fired a barrage of missiles including a novel intermediate-range ballistic missile against the city of Dnipro in eastern Ukraine.

While the missile was not an intercontinental ballistic missile like the Ukrainian officials initially claimed, Pentagon reported that similar missiles could be refitted to carry nuclear warheads as well. Both sides have called past week’s events an escalation in the war, that has now lasted more than 1000 days. Despite the sabre-rattling on the battlefield, Reuters’ sources also reported Putin would be ready to discuss ceasefire when president-elect Donald Trump enters the White House. We remain doubtful that finding common ground around the negotiation table will be as easy as Trump has suggested.

Equity markets traded with a shaky, yet generally positive sentiment in the US, and oil prices rose modestly. Weak set of flash PMIs from the euro area pushed rates lower on Friday, as the composite index plunged back into contractionary territory (48.1; Oct. 50.0). At the time of writing, markets are pricing more than 50% probability for the ECB’s 50bp rate cut in December. Broad USD continued its post-election rally supported by solid outlook for the US economy, and EUR/USD is already trading around 1.04. We have been strategically bullish on the greenback for several years, and earlier this week we shifted our 12M EUR/USD forecast even lower to 1.01.

Next week will be a quiet one in terms of macro data. Main focus will be on November flash HICP data from euro area on Friday, with early signals from German and Spanish country data coming already on Thursday. We expect base effects from weaker reading a year ago to boost headline inflation to 2.3% in y/y terms (from 2.0%) and core inflation to 2.8% y/y (from 2.7%). On a monthly level, inflation momentum has still likely continued moderating, which should further pave the way for ECB cuts in December and beyond. Several ECB officials will be on the wires leading up to the release, including Lane on Monday as well as Villeroy and Nagel on Tuesday.

In the US, focus will be on October’s PCE data, which includes the Fed’s preferred gauge of inflation. Earlier CPI release suggested that price pressures remained stable on a monthly level in headline and core terms. Markets remain divided over whether the Fed will cut rates in December, and FOMC’s November minutes on Tuesday could offer some additional clues on the most likely rate path going forward – we still call for a 25bp cut.

On the other side of the world, Reserve Bank of New Zealand (RBNZ) has become one of the most aggressive central when it comes to rate cuts. We expect another 50bp reduction next week, but markets are speculating with a small chance for an even larger 75bp move.

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