Market Correction

The Obama administration hoped global markets would punish Russia. It's not happening.

When President Barack Obama stepped before the White House press corps on Friday to announce that Russia would face "costs" for moving military forces into Ukraine, it remained maddeningly unclear just how Washington planned to punish Moscow for its surprise invasion.

By Monday, it appeared those costs had become better defined, as markets around the world plummeted on the news Russian forces had seized de facto control of the Crimean peninsula. The ruble traded at record lows, and the Russian Central Bank had to spend in excess of $10 billion to prop up its ailing currency. By day's end the bank jacked up a key interest rate by 150 basis points to halt the ruble's slide. Meanwhile, Russian stocks plummeted, with key state-led companies such as Rosneft and Gazprom seeing double-digit losses. The Russian benchmark Micex index fell 10 percent, erasing a year's worth of gains.

The market, it seemed, had accomplished what the White House had not: Quickly crafting and executing a punitive response to actions that have brought U.S.-Russian relations to their lowest point since the Cold War.

But then global markets did something unexpected: By Tuesday's end, they had more than recovered from the previous day's losses. "We haven't seen military action being the focus," Joyce Chang, JPMorgan Chase & Co.'s global head of fixed-income research, told Foreign Policy. "Obama just seems more unlikely to go there. That's why I think the market is rallying."

With a full-scale shooting war in Ukraine appearing less likely than during Monday's frenetic trading, U.S. analysts struck a cautiously optimistic tone. In his first public comments on the presence of Russian troops in Crimea, Russian President Vladimir Putin wholeheartedly defended his decision to deploy forces there but said that he saw no immediate need to send his troops elsewhere in Ukraine. "For the moment there is no need for that, but the possibility still exists," he said. "On the whole, it seems to me that it's stabilizing." Moreover, the Russian defense minister ordered Russian troops taking part in an exercise near Ukraine's borders to return to their bases.

Those comments helped markets recover some of Monday's losses. By day's end, the Dow had gained 227.85 points, or 1.4 percent, and the Micex, the benchmark Russian exchange, saw gains of 5.3 percent, its largest single-day gain since May 2010. The ruble, meanwhile, regained 1.4 percent of its value against the dollar -- this after trading at record lows only 24 hours earlier. Both Rosneft and Gazprom recovered some of their losses on the previous day. Correspondingly, investors abandoned the safe-haven assets to which they had fled. Gold futures fell just under 1 percent, and the yield on 10-year Treasury bonds increased to 2.691 percent from their one-month low in late trading Monday.

Win Thin, global head of emerging-market currency strategy at Brown Brothers Harriman, said he was surprised markets had rebounded so quickly. He said there was an "uneasy calm" as investors waited to see what Putin would do next and how the West would react.

Meanwhile, the Obama administration is slowly assembling a package of punitive economic measures targeting Russia, including some specifically aimed at senior Russian officials involved in the invasion of Crimea. "We're not just considering sanctions, given the actions Russia is taking," State Department spokeswoman Jen Psaki said Monday. Administration officials have spoken of visa bans and asset freezes, but it's not clear what other measures are under consideration.

In a blow to the Obama administration, European allies, including Britain and Germany, oppose imposing sanctions on Russia and have instead called for intensified diplomacy. Both countries have deep trade ties to Russia -- much more so than the United States -- and are heavily reliant on Russian natural gas, so they are reluctant to impose punitive measures that could harm their own economies as well.

The Obama administration has also promised an aid package to prop up the struggling Ukrainian economy, but that measure requires congressional approval. Negotiations in the relevant committees of the House and Senate are only just underway. According to congressional aides in both chambers, the bill will likely include $1 billion in loan guarantees, aid for civil society and election monitoring, and authorization for sanctions against Russian officials.

Beyond diplomatic reprisals such as the cancellation of military ties and suspending preliminary talks ahead of this summer's G-8 meeting, little substantive pressure is being brought to bear on Russia. With markets rebounding, Moscow has even less incentive to heed Western calls for a withdrawal from Crimea.

Thin, the Brown Brothers Harriman strategist, said it's far from clear that the administration will be able to impose punitive measures on Russia given the European opposition to sanctions. "The U.S. can't really do anything in the U.S. if London's still open for business," Thin said in an interview. But he said that there was also considerable risk that another morning of bad headlines could send the markets diving again.

At the moment, the prevailing wisdom on Wall Street holds that the worst of the crisis may have passed. "My base case scenario is that the European countries will express along with the United States outrage at Russia's actions in Crimea but most European countries will also take a sanctions-lite approach as long as Russia does not begin military operations in the rest of Ukraine," said Chang of JPMorgan Chase, who added that the threat of war and instability has led her to shave a full percentage point off of her GDP growth forecast for Russia, from 1.8 percent to 0.8 percent.

Global markets, then, are feeling cautiously optimistic -- but that's something Putin could easily change. "We finally see a faint glimmer of light at the end of the tunnel," said Tim Ash, head of emerging markets research at Standard Bank Group. "Let's hope this is the exit and not a Russian truck coming the other way."

Staff writer John Hudson contributed to this report.

Andreas Rentz/Getty Images


Front to Back

The most powerful rebel alliance in Syria -- the Islamic Front -- is on the verge of collapse.

Two developments took place in the past month that point to remarkable changes within Syria's Islamist landscape. In early February, al Qaeda's central leadership disavowed the Islamic State of Iraq and al-Sham (ISIS) -- a favor ISIS repaid a few weeks later, when it launched a suicide attack that killed al Qaeda's representative in the country, Abu Khalid al-Suri.

The killing of Abu Khalid, a longtime comrade of both current al Qaeda leader Ayman al-Zawahiri and Osama bin Laden and also one of the founders of Syria's powerful Salafi group Ahrar al-Sham, seems destined to cause an escalation in rebel groups' efforts to drive ISIS out of the country. Shortly after Abu Khalid's death, Jabhat al-Nusra, al Qaeda's official affiliate in Syria, gave the rival jihadi group a five-day deadline to end infighting or be expelled from Syria and Iraq.

But while the killing of Abu Khalid has rallied many groups against ISIS, the ongoing infighting has also polarized jihadists -- and called into question the survival of what had been the single strongest rebel alliance, the Islamic Front. The Salafi alliance appears to be crumbling as its members adopt different policies on whether to confront ISIS. As a result, senior Free Syrian Army commanders believe they have an opening to regain their preeminence as the strongest anti-Assad force on the ground.

Several Islamic Front brigades have been weakened by deep internal divisions over how to handle ISIS. The formerly powerful rebel brigade Suqour al-Sham, for example, has now been reduced to a minor faction after two of its most powerful factions defected. The brigade made the fatal mistake of first aligning itself with the Free Syrian Army to fight ISIS -- but then, after other members of the Islamic Front joined the battle, signing a truce with ISIS. Its two constituent parts that left, Liwa Dawoud and Liwa Siyoof al-Haqqa, were sympathetic to ISIS; Liwa Dawoud first joined the jihadi group outright, but on Feb. 18, formed a new alliance that distanced itself from both the Islamic Front and ISIS.

Two top rebel leaders told Foreign Policy that the Islamic Front had collapsed in all but name. Speaking from northern Idlib governorate, Col. Haitham Afisa, the Free Syrian Army's newly-appointed deputy head, said that Islamic Front members recognize the failure of the alliance, but due to the fact that they present themselves as the most powerful alliance in Syria, they fear that its official demise would incur significant financial and political costs. He added that part of the challenge for the Islamic Front has been that many of its fighters required religious rulings to fight fellow jihadists in ISIS. "Each one needed a fatwa," he said.

Ahrar al-Sham has also been riven by disagreements over what to do about ISIS. Some of its factions, for example, manned checkpoints with the jihadi group, while others were furious at ISIS for killing their commanders. The unprecedented polarization in the wake of the continuing jihadi infighting has revealed these fault lines, and the sand seems to be slowly shifting underneath the Islamic Front as a result.

In the wake ofAbu Khalid's killing, the reluctance to fight ISIS may wane. The al Qaeda representative had tried to avoid infighting at any cost: At the height of the battles against ISIS, for example, he signed a truce allowing the jihadi group's fighters to cross freely into the Aleppo countryside. The truce upset many Islamic Front fighters, who criticized it for deviating from the alliance's broader position. Ahrar al-Sham justified it by saying clashes with ISIS in that area would place the Jarrah military base at risk of being captured by the regime's forces.

For all jihadi groups, except ISIS, the overriding priority had been to safeguard jihad from any internal and external threats -- that's why al Qaeda central disavowed the group and why al Qaeda's official faction in Syria, Jabhat al-Nusra, joined the fighting against ISIS. According to sources close to Ahrar al-Sham fighters, members long pushed for confrontation with the rival group, but top leaders such as Abu Khalid had repeatedly refused. Now, with his removal from the military scene, the voices calling for a confrontation may win out.

On the ground, the Islamic Front is increasingly checked by emerging rebel alliances. In the Idlib countryside, Jaish al-Sham is emerging as a strong rival, while in Aleppo and its countryside, Jaish al-Mujahideen enjoys a strong presence. In the areas surrounding Damascus, the presence of the radical alliance Ajnad al-Sham, which was formed on Dec. 6, almost matches that of the Islamic Front's Jaish al-Islam. In other provinces, including Raqqa, Deir Ezzor, Hasaka, and Deraa, the Islamic Front is hardly a dominant force.

According to one rebel commander from Idlib, the continuing infighting has proved that the influence of the Islamic Front had been greatly exaggerated. Despite the fact that its fighting strength had been estimated at between 40,000 to 70,000 fighters, the alliance has been unable to decisively expel ISIS from areas under its control. The group has been hindered by the reluctance of many of its fighters to join the battles against ISIS, as well as the decision of others to leave the alliance.

Jihadi infighting is set to intensify in the days and weeks ahead, and polarization will continue to shape the landscape. In his statement on Feb. 25, Jabhat al-Nusra leader Abu Mohammed al-Joulani threatened ISIS that "hundreds of brothers in Iraq" are ready to face it down there -- perhaps a confirmation of rumors that Jabhat al-Nusra plans to form a rival group in Iraq.

These ideological realignments within Syria's jihadi sphere are still fluid and unpredictable. But the deterioration of the Islamic Front, together with the weakening of ISIS and the rise of moderate groups like the Syrian Revolutionary Front, has leveled the playing field somewhat among the different ideological groupings. And as a result, Free Syrian Army commanders see this as a perfect opportunity to rise again. They hope to convince relatively moderate rebel brigades, like Liwa al-Tawhid, to rejoin their cause.

"We do not want the Islamic Front to be weakened," Colonel Afisa told me. "But if other groups see that the [Free Syrian Army] is effective, many will rejoin us."

Photo: BARAA AL-HALABI/AFP/Getty Images