Insight

Thoughts on the Russia-Ukraine conflict

Thoughts on the Russia-Ukraine conflict
Key takeaways
A humanitarian catastrophe
1
The sense of shock across Europe and the world is palpable, and our thoughts are with those affected.
Has our 2022 outlook changed?
2
We don’t think global growth will be significantly affected, especially given the increased savings buffer that has developed over the last few years.
A third successive shock?
3
Governments forced the financial system to become more resilient after the GFC. The pandemic highlighted supply chain issues. What are the implications this time?

The invasion of Ukraine is first and foremost a humanitarian catastrophe. The sense of shock across Europe and the world is palpable, and our thoughts are with those affected.

The human and political implications are, and will be, more significant than the market impact we have witnessed over the past week.

As the situation evolves, we share our thoughts on what that market impact looks like and provide an update on our long-term outlook.

Has our outlook changed?

Our view for 2022 was already more muted for bonds and equities than in prior years, given the significant run in equities and the growing hawkishness of central banks.

The Russian invasion has increased price volatility and led to a further uplift in commodity prices, especially in oil and gas.

Consumers, most notably in Europe, will be impacted by these price hikes. However, we don’t think global growth will be significantly affected, especially given the increased savings buffer that has developed over the last few years.

Assuming the fighting doesn’t escalate beyond Ukraine, global growth expectations are likely to be trimmed, primarily in Europe, but not dramatically.

However, the invasion is yet another negative supply shock for the global economy, which may push inflation up while weighing on growth.

In the short-term, uncertainties surrounding the impact on growth and inflation are likely to dampen the hawkish inclinations of central bankers.

This should reinforce the European Central Bank’s (ECB) more cautious stance and lead the Bank of England (BoE) and the Federal Reserve (Fed) to review the scale and speed of their rate hikes, which we continue to see as likely given inflation is at its highest in decades.

The weaponisation of energy supply

Europe is more exposed than other regions to any weaponization of energy supply, given its reliance on Russian gas.

It is worth noting that gas is less of a global commodity, so the curtailment of gas would have more of a regional impact for Europe. Meanwhile, a supply shock in Russian oil would hit global oil prices and impact global demand more broadly.

It is also worth noting that spending on energy is a significantly lower share of household income than it was in the 1970s. Therefore, while energy shocks are still impactful, they are less so than they would have been in the past.

A third successive shock, post-pandemic and global financial crisis?

Given our longer-term outlook of around one to three years, we have also considered the implications of this as a third successive shock, post-pandemic and global financial crisis (GFC).

Governments forced the financial system to become more resilient after the GFC and the pandemic highlighted problems in supply chains. Now Ukraine will put a focus on the geopolitical necessity of economic and military resilience.

There could be a number of consequences, including:

  • Onshoring
  • The expansion of alternative supply sources
  • Increased inventory levels of important goods and commodities
  • Increased defence spending
  • Increased spending on alternative sources of power generation and supply

We should also see large increases in US infrastructure spending and significant corporate and government investment in climate mitigation.

Reversing the globalisation trend?

The need to build up resilience is often at odds with the globalisation trend of the last 30 years. It could lead to an increased fragmentation of the global economy, which would likely impact the financial system – not just the traded goods system. 

The weaponization of SWIFT, the freezing of internationally held FX reserves, and even Switzerland agreeing to freeze Russian money underscores the leverage that developed economies have at their disposal. It also illustrates how political will can threaten sovereign stability.

This will presumably accelerate moves by China and others to develop alternative US dollar payment systems to reduce overreliance on the dollar as the global reserve currency – another form of resilience.

This suggests real assets could continue to be in favour. 

A steep increase in global investment

Should these resilience measures materialise, they would support a steep increase in global investment. This is on top of spending increases in US infrastructure, and corporate and governmental investments in climate mitigation.

This could reverse the secular stagnation trend of the last 30 years, as excess savings are re-directed to investment.

Could the low inflation, low interest rate environment of most people’s entire financial careers be turning on its head?

It’s a risk we continue to debate. 

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