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Key Points

• While market stress has receded last week, hurdles on the road to a settlement in Ukraine should not be underestimated.
• The first signals from the real economy suggest business and consumer confidence are visibly hit.
• The Fed fell on the hawkish side last week, while C. Lagarde was more dovish than at the Governing Council meeting press conference. This may be informed by lack of progress on a joint fiscal response.

The level of stress on the energy and equity markets has declined over the last two weeks. This was fueled by some positive noises around the negotiations between Moscow and Kyiv. Yet, the hurdles on the road to a settlement should not be under-estimated in our view. While some form of “neutralization” is acceptable to Kyiv, demilitarization probably is not. Moreover, Ukraine will want more solid third-party security guarantees than the “Budapest memorandum” of 1994. Finally, it’s highly likely that Moscow would request the sanctions to be lifted in exchange for a ceasefire or a proper peace agreement, which the West is likely to be reluctant to grant. A “proper deal” would be complex and involve many more parties than “just” Russia, Ukraine, and a go-between. In the meantime, Moscow is likely to try to push further on the ground to try to maximize its leverage in future negotiations. This in turn could lead to an even deeper humanitarian crisis, with more public opinion pressure on western governments for more sanctions. This would be consistent with further spikes in stress and hence with more episodes of market volatility.

The somewhat better mood on the markets contrasts with the first signals from the real economy which suggest that even in countries such as France which are relatively well protected against the economic fallout from the Ukraine war, business and consumer confidence is visibly hit. We are not in recessionary territory, but manufacturing is struggling. We are concerned by a possible “inventory whiplash”: it’s precisely when the “inventory glut” – legacy of the reopening of the economy – was starting to be satiated that firms are facing yet another cost shock and are revising their demand expectations.

For now, the Fed is “unmoved” by the developments in Ukraine and is intent on proceeding with a fast pace of normalization. Apart from the decision to hike by 25 basis points and not 50 as Bullard was calling for, the Fed’s statement and Powell’s press conference were on the very hawkish side.  Conversely, we found Christine Lagarde’s latest speech less hawkish than at the Governing Council meeting press conference. Her willingness to insist on data dependence and gradualism, as well as finally the (imprecise) recognition that a new programme could be set up to deal with fragmentation may be informed by the lack of progress on a joint fiscal response at the European level.