Markets Rise But Russia In Focus--Update

By Dow Jones Business News, 
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By Josie Cox

Mounting tensions between Russia and the West continue to dominate the mood across European markets Tuesday, although stocks are rebounding from Monday's lows.

Russia's Micex index was able to claw back some of its recent losses, rising 1.5% by midmorning. The dollar-traded RTS index, meanwhile, added 1.6% and the ruble recovered somewhat against the dollar to trade at 35.05. The pan-European Stoxx Europe 600 added 0.6% having closed the previous session down 0.5%.

International investors appeared to welcome indications that separatists are willing to work with international rescue forces in an attempt to establish what and who caused a commercial jetliner, flying from Amsterdam to Kuala Lumpur, to crash last Thursday killing all of the 298 people on board.

In New York, the United Nations Security Council passed a resolution condemning the downing of the plane, and calling for an independent international investigation. Russia voted for it. ( Follow the latest updates on the Malaysia Airlines crash in Ukraine. )

Gold, an asset often sought at times of stress, fell 0.5% to $1,307.6 an ounce while the yield on the U.S. 10-year government bond, also a safe-harbor, rose marginally to 2.47%. Yields rise as bond prices fall.

Japan's yen, meanwhile, was broadly unchanged on the day at Yen101.48 against the dollar. Elsewhere in currency markets, the U.S. dollar hit a one-month high against the Swiss franc and near five-month high against the euro, with strategists unable to pin down an exact reason for the move. Citigroup, however, said that the flows were predominately being driven by long-term buyers such as insurance and pension funds.

Jim Reid, a strategist at Deutsche Bank AG said that the geopolitical backdrop is now presenting investors with a dilemma.

"In my mind the market isn't assigning a high enough probability of this situation escalating to uncomfortable levels but the reality is the most likely outcome is that it doesn't," he said.

He adds that the question investors should be asking themselves is whether to position for the most likely outcome along with the crowd, or to stand more alone and position for the "lower probability but higher impact" outcome.

"Over a career you'll probably get higher overall returns with the latter strategy but you may have more uncomfortable moments explaining and surviving frequent small underperformance," he says.

What might cast more light on the situation, is a meeting scheduled Tuesday for European foreign ministers, at which they are expected to approve sanctions against a range of Russian oligarchs in response to the crash.

UBS economist Paul Donovan said it has been many years since investors had to seriously consider political risks in developed financial markets and as such, there is "potential for misinterpretation or complacency around political risks."

In a note to clients he wrote that, while the extent of possible sanctions is unclear at the moment, it is likely that there would be a significant impact on wider Europe as well as Russia.

Economists at Morgan Stanley agreed, adding that sanctions would likely "reduce access to external funding markets" , putting downward pressure on the ruble.

"Increased uncertainty could hit consumption and investment, creating a downside risk to our 0.8% growth forecast for the year," they said in a note.

Earlier this month, the International Monetary Fund said that Western sanctions on Russia would likely push Moscow toward increased self-reliance and hamstring reforms sorely needed to boost flagging economic growth. The IMF predicts economic growth of 0.2% in Russia for this year and 1% for 2015.

Elsewhere Tuesday the conflict in the Middle East remains high on investors' agendas. Late Monday, the U.S. pushed for an immediate cease-fire in Gaza, as Israeli officials indicated they would keep up efforts to destroy tunnels that Hamas is increasingly using to mount cross-border attacks.

The death toll in Gaza rose to 571 on Monday, the Palestinian Health Ministry said--that is up more than 300 in the four days since Israel's ground invasion began. More than 149 children are among the dead, the officials said.

Beyond geopolitical tensions, the corporate earnings season remains in focus in Europe. In the U.K, Royal Mail PLC warned of intensifying competition in the parcel delivery market, sending shares down more than 3.5% to the bottom of London'sFTSE 100.

In the financial sector, Credit Suisse Group AG reported a larger than expected loss in the second quarter, as it continues to absorb the impact of a U.S. legal settlement reached two months ago. Shares in the bank were down 2% by midmorning.

In the U.S., the S&P 500 is expected to open 0.2% higher on the day, though futures don't always accurately predict moves at the open.

Write to Josie Cox at josie.cox@wsj.com


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