Russia's standoff with the West continues to intensify as Vladimir Putin announced he would recognize two self-proclaimed separatist republics in eastern Ukraine. The Russian president also went on to sign aid and cooperation pacts with regional leaders in Donetsk and Luhansk (which include the right to build military bases), at a televised Kremlin ceremony that was condemned by the U.S. and EU. "I consider it necessary to take the long overdue decision to recognize the independence and sovereignty," Putin declared. "Ukraine for us is not just a neighboring country, it is an integral part of our own history, culture and spiritual space."

Response: Some sanctions were announced unveiled by the U.S. and its allies as Putin planned to send in peacekeeping forces (see below), though Moscow has continued to deny plans of an invasion. Ukraine said it will also stick to a peaceful path, with President Volodymyr Zelenskyy emphasizing that Putin merely "legalized" troops already present in self-proclaimed republics since 2014. "We're dedicated to diplomatic means of solving this issue. We're not reacting to any provocations. This is our choice. We are on our land. We're not afraid of anyone and everyone."

Following the news, the UN Security Council held an emergency meeting, but with Russia being one of the five countries that hold veto power, measures like sanctions are non-starters. Russia also holds the rotating presidency this month, so it sets and chairs the agenda for council meetings, likely shielding itself from further trouble. Meanwhile, the U.S. State Department on Monday evening relocated its diplomatic staff in Lviv, Ukraine, to Poland, citing safety and security reasons.

Next steps: President Biden "reiterated that the United States would respond swiftly and decisively, in lockstep with its allies and partners, to further Russian aggression against Ukraine." The developments may also torpedo a last-minute summit with Biden, which was arranged by French President Emmanuel Macron over the weekend. The White House said it was prepared to meet with Putin "in principle" - if Moscow refrained from further invading Ukraine - but U.S. officials said they can no longer commit to a gathering that has a "predicate that Russia won't take military action, when it looks as imminently like it will." (1 comment)

Tensions hit markets

U.S. markets were closed for Presidents' Day on Monday, but intensifying tensions between the West and Russia was on full display across the globe. Russia's benchmark stock index, the MOEX, plunged 10.5% for its largest daily percentage decline since the invasion of Crimea in 2014, while the pan-continental STOXX Europe 600 slid 1.3%. Jitters are also showing up in America, with futures contracts tied to the Dow and S&P 500 slipping 1.3% and 1.5% overnight, while the Nasdaq fell back 2.2%.

Analyst commentary: "A limited invasion of Donbas would be a temporary headwind on risk assets, but we would not view that as a bearish gamechanger unless it spiraled into a broader conflict between Russia and the NATO," Kinsale Trading wrote in a research note. In Goldman Sachs' worst case scenario, a 10% decline in the Russian ruble would push the S&P 500 down another 6% compared to Friday's close, with several more percentage points of weakness seen in Europe. Deutsche Bank also pointed out that typical geopolitical selloffs are usually around 6%-8% on average, taking three weeks for stocks to bottom and another three for them to recover.

Elsewhere, the energy sector is on watch, with Russia supplying about 40% of the EU's natural gas supplies via pipeline. Dutch gas futures, a European benchmark, surged as much as 13% to €82 a megawatt-hour, while natural gas futures (NG1:COM) in the U.S. traded up 6% at $4.72/mmbtu. Moscow is also a key oil player, producing roughly 11% of the world's supply (or 10.5M barrels per day), sending WTI crude futures (CL1:COM) up 3.7% to $94.46/bbl in response to the developments. "We could see prices surpass the $100-a-barrel mark very quickly and it even has an upside of $10 a barrel if we start seeing most sanctions being placed on Russian oil exports," said Sri Paravaikkarasu, Asia oil lead at FGE.

Other commodities were also impacted, with Russia (and Ukraine) being a major supplier of metal and grain. Aluminum closed in on an all-time record, rising as much as 1.9% to $3,342 a ton on the London Metal Exchange, while Chicago wheat futures (W_1:COM) jumped to a near one-month high as trading resumed after Presidents' Day. Together, Russia and Ukraine account for a quarter of global trade in the grain, and concerns about Black Sea shipment disruptions could send soaring food costs even higher.

Eye on safe-havens: The uncertainty led investors to seek the relative safety of sovereign bonds, with the yield on the benchmark 10-year Treasury sliding as much as 7 basis points to 1.846%. Bullion also caught a bid as gold touched an eight-month high at $1914.40 an ounce. Interestingly enough, cryptocurrencies (the new age safe-haven touted by crypto believers) took a hit on the news, suggesting it is still trading in line with the riskiest of assets. At the time of writing, Bitcoin (BTC-USD) - referred to by some as digital gold - is down 6.6% to $36,808. (25 comments)

Sanctions begin

Vladimir Putin's recognition of two breakaway regions, and his order to send in "peacemakers," does not constitute a "further invasion" that would trigger a broader sanctions package since it's "territory that they've already occupied," a Biden administration official told Reuters. The U.S. will continue to pursue diplomacy with Russia until "tanks roll," which it believes could happen at any time. Putin's announcement will still prevent American investment, trade, and financing in Luhansk and Donetsk, while additional measures from the White House will be announced later today.

What would a wider package look like? As the U.S., U.K. and EU discuss the details behind closed doors, Germany halted its approval of Nord Stream 2. The $11B gas pipeline was designed to double the amount of gas flowing from Russia to Germany, but things could get ugly quickly, with Moscow exporting nearly 40% of the EU's natural gas supply. The West may also sanction Russia's financial sector - as well as Vladimir Putin's inner circle - which would be more targeted than the latest round of sanctions.

With Putin's allies located across the highest levels of industry, the penalties could affect the business interests of oil majors operating in the country like BP (NYSE:BP), Shell (NYSE:SHEL) and Exxon Mobil (NYSE:XOM), and commodity traders like Glencore (OTCPK:GLCNF), Vitol, Trafigura and Gunvor. The last time around, when Russia annexed the Crimean Peninsula in 2014, sanctions worked a little differently. For example, the penalties leveled against Rosneft (OTCPK:RNFTF) didn't limit its supply or production, but rather restricted its ability to fund future growth by limiting its Western financing, while curbing access to certain technologies used in exploration activities.

Outlook: Reports suggest that the West is preparing a series of sanctions, which could be implemented in successive rounds depending on the degree of the invasion. There is also the risk that Russia may unveil its own counter-sanctions, like severing oil and gas supply completely, which would drive up the cost for consumers. At its worst, it could spark a sanctions war, that could cut Russia's banks off from the SWIFT international banking system or ban Western investment funds from holding Russian government bonds. (40 comments)

What does Putin want?

"Russia wants to revise the post-Cold War settlement. It wants to talk about no more NATO expansion and it wants to talk about no more NATO military, structural or institutional presence in countries like Ukraine," said Michael Kofman, Director of Russia Studies at research and analysis group CNA. "The Russian goal has always been to impose their will on Ukraine, to secure Ukraine's strategic orientation and the like, but without actually having to control the territory or pay for it."

Snapshot: "Going to reiterate. Russia is not unilaterally giving away its main leverage over Ukraine, for nothing (plus getting sanctioned), or just introducing troops into occupied territories where it has already kept forces on rotation for 8 years. That's not what this is about," Kofman added in a tweet. "If you look at the evolution of this crisis, Putin's grievances, and the disposition of Russian forces, it suggests that this is a play for Ukraine, with maximalist aims. Recognition of DNR/LNR is just a significant political step in that rapidly unfolding scheme."

"For Putin, it's not just 30 years of historical wrong but centuries of injury inflicted on Russia, the Soviet Union and the Russian Empire," explained Fiona Hill, senior director for European and Russian affairs on the National Security Council during the Trump administration. "Russia wants to have coercive power. This is what this is about."

Go deeper: "Right now I have my doubts that the European political elite and diplomats understand the full complex of problems they will run into as Putin works to advance his agenda," said Aleksei Chesnakov, a former adviser to the Kremlin on foreign policy. "He wants more decisive steps militarily, politically and economically. He is ready."

Today's Markets

In Asia, Japan -1.7%. Hong Kong -2.7%. China -1%. India -0.7%.
In Europe, at midday, London +0.2%. Paris +0.1%. Frankfurt -0.2%.
Futures at 6:20, Dow -1.3%. S&P -1.5%. Nasdaq -2.2%. Crude +3.7% $94.46. Gold +1.2% at $1914.40. Bitcoin -6.6% to $36,808.
Ten-year Treasury Yield -5 bps to 1.87%

Today's Economic Calendar

9:00 S&P CoreLogic Case-Shiller Home Price Index
9:00 FHFA House Price Index
9:45 PMI Composite Flash
10:00 Consumer Confidence
10:00 Richmond Fed Mfg.
1:00 PM Results of $52B, 2-Year Note Auction
1:00 PM Money Supply
3:30 PM Fed's Bostic: "Role of the Federal Reserve in the Community"

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