How Ukraine's Impact on the Markets Bullied a Bully

World markets heaved a sigh of relief today (Tuesday) as Russian President Vladimir Putin appeared to soften his position on Ukraine, but don't look to politics for an explanation.

Instead, it was Ukraine's impact on the markets - namely Russian stocks and the ruble - that caused this sudden change of heart.

ukraine's impact on the marketsWhile many of the world's political leaders, including U.S. President Barack Obama, condemned Russia's de facto invasion of the Crimea region of Ukraine while threatening political and economic consequences, Putin had already taken that into account.

Remember, Putin is no novice on the world stage. He served as a KGB agent for 16 years in the old Soviet Union and has effectively run Russia since 2000.

His excursion into Crimea was well-planned and calculated. He knew the West would refrain from a military confrontation, and that he would face warnings and threats of sanctions. In Putin's mind, the strategic value of the Crimea - it's the home of Russia's Black Sea fleet based in Sevastopol - outweighed whatever actions the West might take.

But Putin underestimated the market reaction to Russian troops moving into Crimea and threatening to enter eastern regions of Ukraine, which has a majority ethnic Russian population.

Most investors in the United States and Europe were preoccupied with Ukraine's impact on the markets there - the Dow Jones Industrial Average dropped 153.68 points, or 0.9%, while the Euro Stoxx 50 index fell 3%.

But Ukraine's impact on the markets in Russia was far more dramatic.

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Ukraine's Impact on the Markets Took Putin by Surprise

Putin's aggressive moves toward Ukraine had money fleeing Russia on Monday. The Russian MICEX index plummeted 11%, losing $60 billion in market capitalization - its worst decline in five years.

"The first risks investors are getting out of are Ukrainian and Russian risks," Paul Lambert, head of currencies at Insight Investment in London, told The Wall Street Journal.

Such big losses must have concerned even a thick-skinned authoritarian like Putin.

But what really set off alarms was a meltdown of the Russian ruble. As the ruble weakened against other world currencies, the yield on Russia's 2027 debt zoomed 52 basis points - reaching its highest levels in nearly two years.

That forced the Russian Finance Ministry to cancel a bond auction planned for tomorrow (Wednesday).

Meanwhile, Russia's central bank sold $10 billion worth of its U.S. dollar reserves in a bid to prop up the ruble, and for good measure hiked its benchmark interest rate from 5.5% to 7%.

The weakness in the ruble must have been especially troubling to Putin because it isn't a short-term problem related to the Ukraine crisis. The ruble was already down 9% this year, putting it among the worst-performing currencies.

Suddenly Putin's belligerence and disdain for the global criticism directed at Russia flipped into a far more conciliatory stance.

"We aren't going to fight the Ukrainian people," Putin said today (Tuesday) after ordering a pullback of Russian troops from the Ukrainian border. "The use of the military is an extreme case."

Ukraine's impact on the markets is the explanation that makes the most sense for the reversal. Hopefully it will continue to restrain Putin's expansionist designs in the region.

At this point, Putin probably sees consolidating his position in Crimea as more strategically important than trying to annex more Ukrainian territory by force, which he has seen will tear apart the Russian markets.

And even an authoritarian leader like Putin doesn't want to risk too much domestic economic turmoil, which is a proven recipe for civil unrest.

"The reaction in the asset markets for Russia were instantaneous and devastating," said Henry Blodgett, chief executive officer of Business Insider, on The Daily Ticker. "And you can sit there and you can say, 'I don't care our stock market's down 10%, and I don't care about the collapsing economy.' .... But pretty much every leader understands that if an economy goes to crap, their odds of staying in power get smaller and smaller and smaller."

What do you think? Is Vladimir Putin more afraid of a collapse in Russia's markets than he is of President Obama and the West? Speak out on Twitter @moneymorning or Facebook.

One of the reasons the Ukraine's impact on the markets was so pronounced is that the region is a focal point for energy, particularly pipelines carrying natural gas from Russia to the rest of Europe. Here's how the crisis will affect gas prices...

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About the Author

David Zeiler, Associate Editor for Money Morning at Money Map Press, has been a journalist for more than 35 years, including 18 spent at The Baltimore Sun. He has worked as a writer, editor, and page designer at different times in his career. He's interviewed a number of well-known personalities - ranging from punk rock icon Joey Ramone to Apple Inc. co-founder Steve Wozniak.

Over the course of his journalistic career, Dave has covered many diverse subjects. Since arriving at Money Morning in 2011, he has focused primarily on technology. He's an expert on both Apple and cryptocurrencies. He started writing about Apple for The Sun in the mid-1990s, and had an Apple blog on The Sun's web site from 2007-2009. Dave's been writing about Bitcoin since 2011 - long before most people had even heard of it. He even mined it for a short time.

Dave has a BA in English and Mass Communications from Loyola University Maryland.

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