What could happen in an escalation between Russia and Ukraine on the global economy?

It's a tense situation that changes every day, but what could happen in an escalation between Russia and Ukraine on the economy?

There’s no doubt that investors will be braced for torrid trading, particularly since the Russian President, Vladimir Putin, has been upping the ante in a growing crisis.

The situation wasn’t helped when Mr Putin recognised two breakaway regions in eastern Ukraine, Luhansk and Donetsk, as independent entities.

It’s these tensions that are rattling global markets and are wiping billions of dollars off the value of Ukrainian and Russian assets.

Moscow’s stocks plunged to their lowest level

But it’s not just the markets in the West that are worried; the rouble lost 3.3% while Moscow’s stocks plunged to their lowest level seen for more than a year after Mr Putin’s decision was announced.

Among those warning about stock-market turmoil are analysts at the Commonwealth Bank of Australia who say that Putin’s decision would exacerbate already high tensions.

They added: “Financial markets now wait for a response from the United States and Europe.”

That response will probably be in the shape of new, tough sanctions.

Analysts say that the measures could include banning US, UK and EU investment funds from holding Russian government bonds.

To put that into perspective, at the end of 2021, overseas investors held more than $43 billion of Russia’s rouble-denominated bonds, known as OFZs.

There are also fears that Russia’s banks may be cut from the SWIFT banking system.

MOEX in comparison to DOW JONES Index

Impact on global market confidence

Financial analysts are also warning that there could be an impact on global market confidence which is also struggling with inflation and fast-rising borrowing costs.

The futures markets are predicted to record falls but there will be a demand for traditional safe assets which has seen US Treasuries rally.

The UBS’ head of emerging markets strategy, Manik Narain, said: “This step (By Putin) increases uncertainty and creates further downside risk for global risk assets.”

His pessimism was shared by the managing partner at Florida’s Case Capital Advisers, Ken Polcari, who said: “We are going to see a negative reaction.”

He added that he was expecting the S&P 500’s ‘low point to be tested’.

Largest stockpiles of international FX reserves

It’s also worth appreciating that Russia holds one of the largest stockpiles of international FX reserves in the world at $630 billion.

However, the cost of insuring the country’s sovereign debt against default has also rocketed since 2016.

One of the issues is that Russia supplies 10% of the world’s gas and oil needs, and in Europe, that figure is 40%.

This has led to Brent Crude futures rising above $96 at one point, its highest price in nearly eight years.

The shares in travel firms have also been badly hit at the prospect of war in Ukraine, and even the shares of BP, despite the rise in oil prices, fell because it has a stake in the Russian energy giant, Rosneft.

WTI Crude Oil
WTI Crude Oil

‘Financial carnage’ will not last

However, not every analyst or commentator is believing the worst with the Spectators’ Matthew Lynn predicting that ‘financial carnage’ will not last should Russian tanks enter Ukraine.

He says that while this will be Europe’s most serious conflict since World War II, geopolitical events ‘rarely make a difference to the markets for more than a few days’.

He points to the Suez crisis, JFK’s assassination and 9-11 to make his point.

There is another issue, the FT’s Darren Dodd, warns and that’s the anxiety of current market conditions.

He says that in commodities, the tensions in Ukraine have worsened what has been a worrying inflationary ‘crunch’.

Part of the problem is that gas prices in Europe have been pushed up high because of storage and supply flow issues, and he warns that sanctions could have a severe effect on the price of materials.

Less than a week’s supply of copper stock

Of these raw material prices, Mr Dodd says that supplies are already badly depleted and that major exchanges have less than a week’s supply of copper stock.

The supply of aluminium is also low, and its price is at a 13-year high.

An analyst at Goldman Sachs warned: “This is an extreme inventory environment,” adding it is ‘unprecedented’.

The Wall Street Journal’s John Sindreu has written that the impact of war in Ukraine on investment portfolios will be hard to discern.

He adds that a conflict will certainly stoke rampant inflation.

Indeed, that’s the view of Simon MacAdam of Capital Economics 

He says that a Russian invasion, or a serious ratcheting up of sanctions, could see two percentage points being added to inflation figures in the West.

Investors are seeking out traditional safe havens

With jittery markets, investors are seeking out traditional safe havens, including the US dollar and gold – which has hit a 13-month high. 

Investors are also rushing back to bonds, even with the risk of increasing oil prices and inflation.

Reuters highlights that one indicator of geopolitical risk for the Eurozone is the exchange rate for the euro/Swiss franc.

It is normally seen as a safe haven by investors and the currency has been at its strongest since May 2015.

Grains and wheat futures

Sanctions would also affect grains and wheat futures with Russia ranking as the world’s top exporter of wheat, while Ukraine is the world’s third-largest exporter of corn, and the fourth for wheat.

Analysts are also predicting that natural gas exports to Western Europe from Russia will also be reduced significantly should sanctions be introduced.

This will, they predict, see gas prices returning to their previous highest levels.

Things also look bleak for currency traders and even without sanctions, the Russian and Ukrainian currencies have suffered.

The worst performing currency in emerging markets in the year to date is the Ukrainian hryvnia, while the rouble is the fifth-worst.

ING’s global head of markets, Chris Turner, said that the current potential conflict presents ‘substantial uncertainty’ for foreign currency markets.

Whether it is currency or commodity uncertainty, or jittery stock markets, investors and analysts alike will be watching carefully the news for reports of increasing tensions or Russian invasion.

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