We are now two days into Russia’s air campaign against anti-regime forces in Syria and both Moscow and the West are rushing to spin the narrative.

The frantic attempt from both sides to shape public opinion has been truly amazing to behold and the sheer amount of coverage speaks to what we said on Thursday about just how important the conflict really is for the Mid-East balance of power.

For the US, portraying Russian airstrikes as supportive of a murderous regime and as an imminent threat to civilians is key, as it allows Washington to explain away the fact that the US and its allies haven’t coordinated their efforts with Moscow. Take the following from CNN for instance, who reports that Russia has made a “strategic blunder” and that by opening an air campaign, Russia risks raising the spectre of the Soviet-Afghan war in the minds of potential jihadists who will supposedly rush into Syria to join the fight:

There is no ambiguity now about Russia’s current tactics in Syria — they are seeking to take over the airspace in the region and be the agenda-setting force on the ground, several senior administration officials told CNN.

 

“Yesterday’s demarche to the U.S. by Russian officials in Baghdad was clear in its intent,” one senior administration official said. “Make sure you don’t have anyone around ISIS targets and get out of the air.”

 

And while U.S. officials have no plans to cede Russia any ground, they also said it appears that Russian President Vladimir Putin made a dramatic chess move that the Russians have not thought through — one official even called it a “strategic blunder.”

 

Had the Russians been clear that they are providing support in Syria to prevent Syrian President Bashar al-Assad regime’s collapse — a scenario that would benefit ISIS — they might have gotten some credit on the world stage.

 

But their very first strikes in the region hit CIA-backed anti-Assad rebel forces, Arizona Republican John McCain, chairman of the Senate Armed Services Committee, said Thursday on CNN’s “New Day.”

 

And U.S. officials note that every bomb against a non-ISIS Sunni target puts them more in bed with Iran and Hezbollah, which are Shiite. U.S. allies in the Persian Gulf warn that this could set off a huge sectarian conflict and that the deeper the Russians get into this, the harder officials believe it will be to get a diplomatic process with the Saudis and others restarted.

 

“It is going to be hugely tempting for the Saudis to start financing their guys again,” another senior administration official said. “Syria will be a magnet for every jihadi, who will rush to fight the Russians, just like they did in Afghanistan. The problem is while this will cause problems for the Russians, it will also mean trouble for the Gulf, when the jihadists come home.”

 

“The Russians can’t be stupid,” another senior administration official said. “This is going to be wildly expensive. And they can’t hold out long. They know in the end there is no future for the guy (Assad) because the whole reason they had to come in is because Assad and his forces were extremely vulnerable. So we are hoping they will come to their senses, stabilize the situation and then we can agree on the Assad piece.”

Now obviously, there are too many absurd statements there to count, but note (again) that Russia has never hid its support for Assad. When Charlie Rose told Putin on national US television that some people believe Russia is in Syria to help Assad, Putin said, quote, “well, you’re right.” On top of that, it’s glaringly obvious to anyone who knows anything about the global balance of power that Russia is there to support Assad and it’s ridiculous for anyone to suggest that Putin isn’t aware of the fact that by supporting the regime, Russia falls squarely on the side of Iran and Hezbollah. It’s also glaringly obvious that ISIS isn’t the only extremist group fighting for control of the country and the notion that the US has now finally managed to identify the “good guys” in Syria after failing to get it right for four years and that now evil Russia is deliberately targeting those good guys simply because they’re the good guys is laughable to the point that one wonders if CNN and others pushed back on being compelled to spin it that way. Additionally, it’s a little late for the US to be concerned about someone inadvertently creating a theatre that in the minds of jihadis will serve as the stage for humanity’s final battle. If Washington was worried about that they might have avoided getting involved in Syria in the first place and they definitely would have avoided training the soldiers who would go on to join the very group that’s perpetuating that idea.

And then here’s WSJ:

The White House challenged Russia’s claim that the airstrikes were targeting Islamic State militants, saying Thursday that Moscow was carrying out “indiscriminate military operations” in areas where the group isn’t operating. A White House official also dismissed the possibility that Russia had inadvertently bombed non-Islamic State areas. U.S. officials say the Russian military bombed one area primarily held by rebels backed by the Central Intelligence Agency and allied spy services.

 

Contrary to claims by the Russian Ministry of Defense, none of the areas that were hit have a known Islamic State presence. At least two of the rebel factions attacked by the Russians—Tajamu Al-Ezzeh and the Central Division—have received weapons including advanced antitank missiles and funding from the U.S. and its allies, according to rebel leaders.

 

The arc that the Russian airstrikes followed begins around the town of Jisr al-Shughour in northern Idlib province near the Turkish border and adjacent to an agricultural area known as the Ghab Plain. It cuts through the central Syrian cities of Hama and Homs and ends at the Lebanese border.

 

Alawites—the regime’s base of support—are concentrated west of the arc in an area that includes Latakia province.

 

Everything east is dominated by the country’s Sunni majority, to which most of those fighting the regime belong.

 

A series of tit-for-tat massacres during the more than four-year conflict have solidified this sectarian fault line.

Yes, the “sectarian fault line” has been solidified and that is a hallmark of Western intervention in the Mid-East. Syria is no different.

And BBC:

Members of the US-led coalition against Islamic State have called on Russia to cease air strikes they say are hitting the Syrian opposition and civilians.

 

In a joint statement on Friday, the US, UK, Turkey and other coalition members said Russian strikes would “only fuel more extremism”.

And best of all there’s Al-Jazeera (which is of course owned by Qatar), who takes it up another notch by suggesting that Russia is now intentionally killing civilians:

Russia accused of striking civilian targets in Syria

 

Activists say warplanes are targeting civilians in areas under control of Western-backed rebels, a claim Russia denies.

For their part, Bloomberg did the American public a favor by laying out the real story, albeit in an article that carries the title “US, Allies Demand Russia Stop Attacks On Syrian Opposition“:

Russian forces are targeting only Islamic State, al-Qaeda affiliated Nusra Front and other terrorist groups, Foreign Minister Sergei Lavrov said Thursday in New York. The Free Syrian Army, a U.S-backed rebel group, was not among the targets and it should have a role in the political process in Syria, he added.

 

“The goal is terrorism,” he said. “And we are not supporting anyone against their own people.”

Assad’s government has been fighting alongside Iranian reinforcements to secure a corridor from the coastal province of Latakia, home to Assad’s Alawite minority, stretching to the capital Damascus, according to Reva Bhalla, vice president for analysis at Stratfor, a geopolitical intelligence and advisory firm based in Austin, Texas. The government has accused Qatar and Saudi Arabia of backing “terror groups,” and dismissed the criticism.

 

“They’re hopping mad in Saudi Arabia, the U.S. And Qatar because of their defeat and the victory of Russia and Syria and the unraveling of the fact that the U.S. and its allies are not serious about fighting” Islamic State, Syrian lawmaker Sharif Shehadeh said by phone from Damascus. “Those who claim to be concerned about the Syrian people are the ones slaughtering the Syrian people through the terrorists.”

There you go. That last passage pretty much says it all.

Meanwhile, the Russian propaganda machine is also in high gear as The Kremlin is jumping at the opportunity to portray Putin as the man who saved the world when no one else was willing to. Here’s Bloomberg again:

Vladimir Putin may have caught the U.S. and its allies off guard by striking Syria, but his propaganda machine was ready.

 

“A hundred dead terrorists,” a news presenter on Russia’s No. 2 network announced early Thursday, just hours after the bombing of what Putin has called “evil-doers” began. She then cut to a correspondent in Syria who lauded the precision of the strikes as aerial footage of the attacks supplied by the Defense Ministry aired.

 

Over on Channel 1, the most-watched station, a parade of politicians, analysts and religious leaders — both Christian and Muslim — rolled by justifying the use of force on both legal and moral grounds. 

 

“This is more than just military strikes against Islamic State,” said the editor of National Defense magazine, Igor Korotchenko, after parliament unanimously authorized the use of force. “We are protecting the values of humanity and taking a stand against the most extreme forms of obscurantism and terror.”

What’s amusing there is that as overstated as it is, that narrative is actually closer to the truth than what’s being fed to the public by the Western media.

In any event, the important thing here is to cut through all of this and extract the bits that help to tell the story of what’s actually taking place in Syria. As we detailed on Thursday, this is effectively a Mid-East coup by Russia and Iran wherein Tehran will replace Riyadh as the regional power broker and Moscow will supplant Washington as the superpower puppet master. And on that note, we close with another excerpt from the WSJ piece cited above:

Iran’s Foreign Ministry welcomed Russia’s military intervention in Syria on Thursday, saying it was the right step to fight terrorism and a move toward bringing stability to the region.

 

“Fighting terrorism effectively requires a strong and serious will and has to be based on cooperation with the governments of Iraq and Syria,” Marzieh Afkham, spokeswoman for the ministry, said according to Iranian media reports.

 

Ibrahim al-Amin, a Lebanese commentator and newspaper editor close to Hezbollah and Iran, said Moscow essentially provided a green light for a counteroffensive against rebels across the political spectrum.

 

“From our side, we can no longer ignore the decision of the axis of resistance, backed by Russia, to not only prevent Assad’s fall but to also weaken all his foes. All his foes without any distinction,” wrote Mr. Amin in the Lebanese daily Al-Akhbar on Thursday.

 

“We must benefit from Russian support to launch tough and decisive battles in several places in Syria,” he added.

 

Before the latest Russian intervention, Iran played a pivotal role propping-up pro-regime militias made up largely of Alawites and Shiites. It has orchestrated thousands of Shiite fighters mainly from Lebanon and Iraq with Hezbollah being in the lead.

 

But thousands of rebels regrouped in several enclaves north of Homs, in towns like al-Rastan and Talbiseh. Russian jets hit both civilian and military targets in these two towns and five surrounding villages, said Rashid al-Hourani, a Syrian army officer from the area who defected to the rebels in 2012.

 

He said the airstrikes were followed with a barrage of artillery fire from several nearby positions where pro-regime Alawite and Shiite militias, including an Iran-backed group known as the Ridha Brigade, have been massing over the past few days.

end

As we’ve documented extensively of late, a host of idiosyncratic political factors have served to exacerbate what was already a very, very bad situation for emerging markets.

This dynamic is most readily apparent in Brazil and Turkey, and although Ankara probably has a leg up in the race for “most at risk from domestic turmoil”, Brazil isn’t far behind as President Dilma Rousseff battles abysmal approval ratings and a recalcitrant Congress in an effort to shore up the country’s finances by convincing lawmakers to sign off on much needed austerity measures.

Meanwhile, a confluence of exogenous shocks that include slumping commodity prices, depressed Chinese demand, the PBoC yuan devaluation, and the threat of an imminent Fed hike have conspired with country-specific political turmoil to send the BRL plunging and that, in turn, has put Copom in what former Treasury secretary Carlos Kawall calls “crisis mode.” 

Of course crises are often costly to combat, especially when you’re an emerging market in the current environment and when it comes to Brazil, the use of alternative measures (like effectively selling dollars in the futures market) to avoid FX reserve liquidation is now weighing heavily on the fiscal outlook. As Goldman noted earlier this week on the heels of the latest monthly budget data, “the overall fiscal deficit is tracking at a disquieting 9.2% of GDP, driven in part by the surging net interest bill, which was exacerbated by the large losses on the central bank stock of Dollar-swaps.” Here’s what Capital Economics had to say after an emergency swaps auction was called by Copom in a desperate attempt to shore up the BRL last week:

First, the size of the planned auctions is reasonably large. Up to $2bn in swaps will be auctioned in total, with auctions so far planned for today and tomorrow (with additional dates presumably added in the future). To put this into context, when the central bank first launched the programme in 2013 the weekly limit on the auctions was $2bn, but by the end it was auctioning less than $200mn a week.

 

Second, we’re not convinced restarting the FX swap programme will do much to stabilise the currency. Indeed, if anything, the initial reaction has been for the real to fall further (it is currently down by 1.8% against the dollar today). Interventions in the currency market rarely have much effect and there are particular issues with using FX swaps as a policy tool. Specifically, if the central bank gets caught on the wrong side of the trade (i.e. the real weakens further), the government will incur a fiscal cost. Losses on FX swap contracts have already inflated the government’s budget deficit by more than 1% of GDP this year, adding to concerns about the fiscal outlook.

 

Finally, the central bank (and government) is clearly becoming spooked by the fall in the real. Generally speaking, while many analysts have worried about the impact of a weaker currency, we have taken the view that it is part of the solution rather than the problem. If currency falls become disorderly, however, that complicates the issue for policymakers. It’s early days, but if the real continues to come under pressure it’s possible that the interest rate tightening cycle could be re-started at next month’s COPOM meeting.

Just how costly has protecting the BRL via swaps been, you ask? For the answer we go to BNamericas:

Brazil’s central bank has already seen losses of almost 2% of GDP as a result of foreign exchange swaps, local paper Valor Econômico reported, citing fiscal data released this week.

 

The program also accounts for about 30% of the increase in gross general government debt incurred in the last year.

 

According to another local paper, Estadão, when looking at the amount spent on both swaps and line auctions, which are contracts to sell dollars with the promise of repurchasing them later with interest, the central bank has already offered 80bn reais to the market in less than one month.

 

In the 12 months leading up to August, the cost of swaps totaled 112bn reais (US$28.0bn), or four times the estimated primary deficit in the 2016 budget. It also exceeded by almost 14 times the primary surplus planned for 2015 (8.7bn reais).

 

This spending represents almost a quarter of the public sector’s interest payment 484bn reais, or 8.45% of GDP in the 12 months leading up to August. The expense also puts pressure on the nominal deficit, which totaled 528bn reais, or 9.21% of GDP, a historical high. When excluding the effect of swaps, the nominal deficit would be 7.26% of GDP, still one of the highest in the emerging world.

Unfortunately for Brazil, “it is not a problem of liquidity, but of fundamentals,” (to quote Barclays), meaning that the pressure on the BRL is likely to continue up to and until the picture improves in terms of commodity prices and until the Rousseff government can prove to the market that plans to get a handle on the deficit are credible. Notably, the currency rallied hard on Friday after Rousseff cut eight ministries, and committed to reduce minister salaries by 10%:

Still, this may ultimately be seen as nothing more than a cosmetic change by the market. But don’t take our word for it, just ask Gustav Gorski, chief economist at Quantitas Gestao de Recursos who, according to Bloomberg, says “the ministerial reform announced today by President Dilma Rousseff is the only way to keep PMDB party in allied base [and] the impact was estimated at 1b reais by planning ministry, which isn’t enough.”

In other words, the pressure on the BRL isn’t likely to abate for long and as outlined above, the irony of using swaps to defend the currency is that it contributes to the very same budget deficit that’s pressuring the FX market in the first place and so because that’s clearly unsustainable, you can expect that in relatively short order, the trajectory shown here…

… will start to look a lot more like the trajectory shown here…

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And because we would hate to disappoint anyone…