Having partied in the euphoria of the previous weekend’s $1 trillion bailout deal, markets ended last week with a considerable hangover and facing up to the emerging reality of the potential negative consequences of the deal. Traders believe that there is a credible threat to the integrity of the euro and, whether eventually proven valid or not, that creates a very negative backdrop for all markets through the summer months. The major worry is that the contagion from Europe’s debt problems and currency uncertainty may start to undermine the still fragile economic growth in the US/EU and may have consequences for growth in Asia.

Against the eurozone and growth uncertainties, volatility is expected to continue in all markets. Still, investors have learned neither to panic sell in bad periods nor to be excessively exuberant in rallies. For most, the strategy of the few months will be to create a shopping list of stocks that they want to hold in the autumn, setting price limits and picking up those stocks when the opportunity is presented.

The risk to that strategy is that the $2 bln of redemptions reported by emerging market funds last week may be extended as retail investors become nervous. Over $75 bln of new investments were placed into emerging market funds last year so if some of that reverses then portfolio managers will be forced sellers. The market action of the next one to two weeks will be critical for that scenario.

Russia funds ended a twelve week stretch of positive flows with a net redemption of $203 mln in the week to Wednesday May 12th.  That, however, compares favourably with the total redemption of $530 mln from China focused funds and $248 mln from Brazil funds.

The continuing fallout from the eurozone debt problems hit all markets hard on Friday and brought the price of oil and other industrial metals/minerals lower. As a result, Russia’s markets, and the ruble, face another very uncertain start to the week Equity prices, especially of stocks in global economic themes and those more sensitive to the currency, are likely to be again very volatile.

A table showing where the GDR/ADRs are trading relative to April highs is at the end of this note.

Note: The RTS exchange extends its trading hours from today. The session will start at 10.00 am (Moscow time) and will close at 6.45pm.

As last week ended, the main theme in all global currency markets was a flight to safety, specifically to the US dollar and the yen and away from the euro. That also undermined the case for high-yielding currencies in economies that are dependent on global economic recovery. The euro is set for a very rocky summer as traders increase bets that neither the political or economic support is strong enough to allow the currency survive. Whether that proves correct or not, traders sense an opportunity to make money by betting on a strong dollar and weak euro over the medium term.

The ruble, although down 0.25% on Friday, bounced 1.4% against the dollar last week to close at 30.171. Against the euro the ruble gained 3.2% to 37.728. Year to date, the ruble is again flat against the dollar and is up 13.1% against the euro. The weaker euro helps Russia’s efforts to keep inflation low as over 50% of imports, including a majority of food imports, are priced in euros. It does, of course, hurt the competitiveness of manufactured exports to Europe and the ability of domestic manufacturers to compete at home, but currently that is not a significant percentage of the economy.

While a generally better than expected 1st Qtr earnings season is winding down in the US, it is picking up pace in Russia. Rosneft will publish its numbers today (see our preview note published Thursday) and Vozrozhdenie Bank will publish on Tuesday.

The April industrial production report is also expected this week, on Tuesday or Wednesday, and that is even more keenly awaited after a disappointing 1st Qtr GDP update late last week. The Federal Statistics Service reported 1st Qtr GDP growth of 2.9% while consensus forecast 4.8% growth. The deputy Economy Minister also said that, on a seasonally adjusted basis, growth may be revised back close to zero for the quarter.

Finance Minister Kudrin continues on a very bearish track as he prepares the 2011 federal budget and hopes to have it approved by the Duma without any pressure for higher spending in election year. With the current average price of oil (Urals is close to $77 p/bbl year to date) the budget outturn will clearly be much better than his latest prediction.

President Medvedev starts a 2 day official visit to Ukraine Monday. One of the main issues to be discussed will be the proposal to merge Gazprom and Naftogaz. We should get a better sense of what the proposal actually means in practice during this visit. The greater likelihood is that Prime Minister Putin’s proposal is directed at eventual joint ownership of the gas transit system.

The backdrop to Medvedev’s visit is that Moscow is in a hurry to integrate itself into Ukraine’s commanding heights industries so as to cut the risk of a repeat of the problems encountered with the previous regime. For Yanukovych’s government the dilemma is that of accepting the much needed investment and subsidies while trying to avoid the criticism that it is selling the nation’s crown jewels.

Internationally, there are several economic reports and surveys due in both the US and in the EU that may have an impact on market sentiment and currencies. Included in the list is the Empire Manufacturing report, due Monday, and housing starts (Tuesday) in the US. In the EU, the ZEW survey of economic sentiment is due on Tuesday and will show how business sentiment has been affected by the debt and currency uncertainty. For a change, Friday is a clear day with no economic reports expected.

Most world markets fell sharply on Friday but, because of the strong rally earlier in the week, most indices recorded net gains for the five days. The MSCI World Index added 2.2% for the week and is now down 3.8% year to date. In the US, the S&P 500 Index lost 1.9% on Friday, despite positive economic indicators, to pull the five day rally back to 2.2% and the year to date gain to 1.8%.

The MSCI Emerging Markets index fell 1.6% on Friday but closed the week with a gain of 3.5% and, year to date, is down 3.0%.

The RTS fell 2.3% on Friday and MICEX ended the day off 1.9%. For the holiday shortened week, the indices respectively closed 5.2% and 4.9% better and year to date are off 0.2% and 1.3%. The MSCI Russia Index gained 5.9% for the week and is down 3.3% year to date.

The price of oil fell sharply on Friday as it was hit with an almost perfect storm. The dollar rally and the heightened concern over Europe’s sovereign debt hit all commodities. The June Brent Futures contract expired and the storage problems in Cushing, Oklahoma pulled the WTI contract to a near $10 p/bbl discount to the December Futures. Saudi reminded the oil market that it sees an average price of $75 p/bbl (Brent) for this year as ideal for both producers and consumers. The current year to date average is at $79.23 p/bbl so, in effect, Saudi is saying that it doesn’t mind a few months of price weakness if that then boosts demand.

Brent, for July settlement, fell $3.50 p/bbl on Friday to end the week at $77.93 p/bbl. WTI for June delivery, which will expire this week, closed at $71.61 p/bbl. The more active July contract traded at $75.43 p/bbl at the close on Nymex. Urals traded at $73.32 p/bbl at Friday’s close and is now averaging $76.99 p/bbl year to date.

The price of almost all commodities fell on Friday as a reaction to the latest burst of concern that Europe’s sovereign debt problems are far from over and may soon start to have a negative impact on economic growth and commodities demand. The dollar rally also had a negative trading impact on commodity prices.

Copper is the most sensitive of the industrial metals to economic news and led Friday’s declines. It fell 3.0% for the session to cut the five day loss of 0.3%. Nickel ended the week down 4.5% at $21,482 per tonne.

Gold traded almost flat on Friday. It ended the week with a gain of 1.4%, at $1,227.8 per ounce, while silver added 4.2% despite losing 1.4% on Friday.

Agriculture commodities were hit hard on Friday as the dollar rally raised fears that consumer demand will remain weak and a number of reports suggest big supply surpluses this year.


This week

Rosneft numbers today. While a generally better than expected 1st Qtr earnings season is winding down in the US, it is picking up pace in Russia. Rosneft will publish its numbers today (see our preview note published Thursday) and Vozrozhdenie Bank will publish on Tuesday. The former is likely to re-open the discussion about the impact of tax breaks in East Siberia while the latter will, hopefully, help clarify the picture of trends in the banking sector.

Hoping that April shows improvement. The April industrial production report is also expected this week, on Tuesday or Wednesday, and that is even more keenly awaited after a disappointing 1st Qtr GDP update late last week (see below). Investors had only modest expectations for the economy in the 1st half but definitely expect to see a more rapid improvement from the 2nd Qtr. The industrial production number will give the first indication of that trend. The consensus is for a 5.7% MoM decline but a 7.3% YoY increase. The April PPI report is due Monday or Tuesday is expected to show a 1.5% MoM and a 17.0% YoY increase.

Medvedev visit to Ukraine. President Medvedev starts a 2 day official visit to Ukraine Monday. The agenda is expected to be wide-ranging and to formalise some deals, e.g. the extension of the lease for the Sevastopol naval base, which have already been agreed. But, no doubt, one of the main issues will be the proposal to merge Gazprom and Naftogaz. That proposal was made by Prime Minister Putin two weeks ago and quite obviously took most people by complete surprise. Officials on both sides have been skirting around the issue ever since. We should get a better sense of what the proposal actually means in practice during this visit. The greater likelihood is that the proposal is directed at eventual joint ownership of the gas transit system (see Strategic Perspective: Gazprom-Naftogaz, of May 3rd). Since Putin made the proposal, it has become even clearer that a full merger would be politically destabilizing in Ukraine and economically undesirable. The backdrop to Medvedev’s visit is that Moscow is in a hurry to integrate itself into Ukraine’s commanding heights industries to cut the future risk of a repeat of the problems faced with the previous regime. For Yanukovych’s government the dilemma is that of accepting the much needed investment and subsidies while trying to avoid the criticism that it is selling the nation’s crown jewels.

Major sentiment survey due in Europe. Internationally, there are several economic reports and surveys due in both the US and in the EU that may have an impact on market sentiment and currencies. The US Empire Manufacturing report is due today and housing starts tomorrow. The CPI and PPI updates are due Tuesday and Wednesday and both are expected to confirm that inflation is still at a very low level. The Leading Indicator report on Thursday is expected to show a 13th straight month of growth. In Europe, the more important report will be Tuesday’s survey of economic sentiment. That will show how business sentiment has been affected by the debt and currency uncertainty. For a change, Friday is a clear day with no economic reports expected.