Investors Zero in on Ukrainian Tug-of-War

With dozens of pro-Russian armed men taking over parliament in Crimea, Western investors briefly expressed jitters on Thursday about the devolving situation in Ukraine for the first time since tensions began boiling over in the key strategic nation late last year.

However, the negative reaction was relatively mild and turned out to be fleeting as U.S. stocks headed north by midday and European equities shed early losses.

"None of this should matter for markets. No one is going to stop Putin if he wants to undertake the mammoth mess of trying to occupy the Ukraine. I am not lying awake at night worrying about a new Cold War," Michael Block, chief strategist at Rhino Trading, wrote in a note to clients.

Still, investors were initially spooked by headlines revealing that dozens of men took control of the parliament and local government offices in the pro-Russian region of Crimea. The men reportedly barricaded themselves inside and raised a Russian flag above parliament, prompting Ukrainian officials to say the country’s military and police had been put on high alert.

Earlier this week, Russia announced surprise readiness tests for 150,000 troops following a standoff outside the Crimean parliament.

All of this is raising fears of a broader regional conflict pitting Russia and Vladimir Putin against Western countries, including the U.S. and major powers in Europe.

“Ukraine itself is a relatively small economy but tends to punch above its weight on the geopolitical scale. It is seen as very important to Putin’s aspirations of expanding its sphere of influence again over the old USSR,” Win Thin, global head of emerging market currency strategy at Brown Brothers Harriman, told clients. “We find it hard to believe that Putin will accept this setback quietly.”

Early on Thursday, the tensions sent U.S. stock futures retreating, drove Germany’s stock market the equivalent of 275 Dow points lower and sent the Turkish hryvnia to fresh lows against the U.S. dollar.

“It’s fair to say that up until today, Western markets haven’t reacted one bit over the past few weeks to what has gone in the Ukraine,” Peter Boockvar, chief market analyst at The Lindsey Group, wrote in a note. “But the instability of the situation at least today is mattering because of the uncertainty of how Putin responds.”

“There’s simply no way Ukraine can continue meeting its external obligations without foreign aid."

- Win Thin of Brown Brothers Harriman

However, the negative reaction quickly melted away as U.S. stocks posted modest gains by midday and the euro advanced against the dollar. Other currencies also bounced off their lows, including the Turkish lira, Hungarian forint and Polish zloty.

“Foremost on everyone’s mind is the worsening situation in the Ukraine,” said Block, noting reports on Wednesday that Russia is trying to re-establish military bases in Cuba, Venezuela and Vietnam. “We can all just hope that the same guy who built the plumbing in Sochi will be in charge of that."

Western powers are scrambling to prop Ukraine’s collapsing economy up with an aid package either from Europe or the International Monetary Fund.

In a statement, the IMF said Ukraine formally requested support and the agency plans to send a fact-finding team to Kiev to “undertake a preliminary dialogue."

The cash infusion is needed because a $15 billion aid package from Russia that ousted President Yanukovych secured has been suspended.

But it’s not a given the IMF will be able to provide the funding because the interim administration in Kiev is having trouble forming a new government. Plus, the strict requirements the IMF may want to put in place may end up destabilizing the country’s economic and political situation.

“It's hard for the IMF to negotiate with a government that hasn’t been formed yet and so the deal, for now, hangs in the balance,” said Thin.

Thin noted that Ukraine’s foreign reserves are sitting at all-time lows, the country’s economy is grappling with the risk of deflation and its short-term debt plus current account/reserves is almost 300%.

“There’s simply no way Ukraine can continue meeting its external obligations without foreign aid,” he said.