Last week was notable for the volatility associated with the geopolitical turmoil in Ukraine. How did this small country's internal strife come to be to such a big issue for markets?

In today's editorial we will provide some background on the turmoil in the Black Sea and assess what kind of impact it had on stock markets.

Background

In the weeks leading up to the crisis, Ukraine was gripped by violent protests against its former President, Viktor Yanukovych.

The opposition to Yanukovych's rule eventually led to his ouster from government and caused him to flee to neighbouring Russia.

The resultant power vacuum caused angst in the Kremlin, which then authorised Russian President Vladimir Putin to use military force in Ukraine.

Ethnic Russians comprise the majority of the Crimean population, which forms Ukraine's southern peninsula and serves as a base for the Russian navy's Black Sea fleet.

The rationale for intervention being that Russian troops were needed to protect Russian citizens and soldiers, who may be vulnerable to attacks stemming from the Ukrainian unrest.

Putin followed by effectively seizing control of Crimea, The defacto takeover of Crimea by Russian forces ignited a firestorm of criticism against Putin by western nations, led by the USA.

Western leaders have largely condemned the move by Putin to seize control of Crimea and have openly threatened sanctions against Russia.

Russian stockmarket collapse

The stock market reaction to the Crimean flare up was as expected, with most major global indices suffering steep declines on the Monday.

However, reports emerged the next day that Putin ended Russian military exercises near the Ukrainian border, easing concerns the standoff would escalate and igniting a major relief rally on international markets.

This is represented below by the one-month trend in the VIX (purple line) and S&P500 (white line).

Source: Bloomberg

The chart clearly shows that volatility – as measured by the VIX - rose in response to the Russian incursion, but then subsided very quickly.

The S&P500 not only recovered all of Monday's heavy losses but since gone on to create new all-time highs.

Notably, most of the volatility occurred on Russian markets, shown below.

Source: Bloomberg

Russia's major equity market, the Micex (white shaded line), collapsed 12% the Monday after news of the troop incursion broke.

Ten year yields on Russian government bonds also spiked (purple line), whilst the rising green line represents the ongoing depreciation of Russia's currency, the Rouble, relative to the US dollar.

Investors have so far focused their wrath on Russian markets, with the spike in government borrowing costs reflecting Russia's move to dramatically hike interest rates in response to Rouble volatility.

The prospect of higher interest rates and a Rouble collapse threaten to tip the Russian economy into recession.

Russia is dependent on outside capital to finance investment in the country. Any trade sanctions that severely restrict foreign capital inflows are likely to have a major impact on economic growth.

Sinking Russian stock prices and the growing threat of recession may ultimately be Putin's Achilles heel, more so than the international political pressure heaped upon him last week.

The Russian President therefore has a lot to lose if the crisis escalates into a full blown invasion of Ukraine.

It is why at this stage, the volatility emanating from the Ukrainian crisis has so far been contained within the Black Sea region.

Weekly Market Wrap: Russia Roils Markets is a post from: Australian Stock Report Market Pulse Blog