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Ukraine : impact on the financial markets

The Ukraine crisis has entered a new phase. This morning Russia began military operations across large swathes of the country, not just in the self-proclaimed republics of Donetsk and Luhansk in eastern Ukraine. Financial markets reacted this morning to these escalating geopolitical risks, with stock markets losing ground across the board. Message from our CIO, Daniel Varela.

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Daniel Varela 04

Ukrainian crisis: a new level crossed

The Ukraine crisis has entered a new phase. This morning Russia began military operations across large swathes of the country, not just in the self-proclaimed republics of Donetsk and Luhansk in eastern Ukraine. As we said in our Market lnsights this week, it is still hard to gauge what Russian President Vladimir Putin hopes to gain from these moves.

Judging by the Kremlin’s claims in recent weeks and the US intelligence reported by the media over the past few days, it would seem that Putin is looking to demilitarise Ukraine by force and perhaps overthrowthe current government. The aim would be to bring Ukraine back into Russia’s sphere of influence so that it is in a similar position to that of Belarus, thereby creating a buffer zone between Russia and the Central European countries that have joined the North Atlantic Treaty Organization (NATO) in recent decades. Financial markets reacted this morning to these escalating geopolitical risks, with stock markets losing ground across the board.

What can we expect in the coming days and weeks?

On the geopolitical level

The worst-case scenario – in which the West is drawn into the conflict – is extremely unlikely and can surely be excluded. European and US leaders have consistently ruled this out in recent weeks. But they have made it clear that they will impose harsh economic and financial sanctions on Russia. More of these are likely to be announced in the coming days.

Even though Ukraine has strengthened and upgraded its army in recent years, without outside help it may be no match for the Russian army, since Russia’s armed forces – particularly its air force – are much stronger. Russia may therefore achieve its military objectives in quite a short space of time.

 

In economic terms

ln terms of the economic impact, Russia and Ukraine’s weightings in the global economy are relatively small. Global growth has remained very robust so far in 2022 – it continues to be lifted as economies reopen and the pandemic fades, which has driven up consumer spending considerably.

The real economic threat will corne from a sharp and sustained rise in energy prices, which would hit Europe particularly hard, especially if Russia reacts to the sanctions imposed on it by cutting its energy supplies to the continent. We’II therefore be keeping a close eye on oil and gas prices in the short and medium term. ln addition, central banks should remain cautious in the short term.

The US Federal Reserve may slow the pace of its long-awaited monetary policy tightening, or even put it on hold. Other major central banks, starting with the European Central Bank, are likely to do the same.

 

In financial terms

Turning to the stock markets, the rising uncertainty caused by geopolitical crises often causes market indices to drop – sometimes sharply. The recent stock market downtrend therefore cornes as no surprise. But history has shown us that these corrections are usually short-lived, especially when the global economy is growing at a solid pace. Stock markets tend to recover their lasses in just a few short weeks -that’s what happened after Russia invaded Crimea back in 2014.

Global stock market indexes have already dropped off sharply from their early-year highs. Valuations are back at attractive levels, especially in the States, and investors are extremely bearish, which suggests that much of the bad news has already been priced in. We therefore think it’s important not to overreact to the escalating military tensions in Ukraine, and we are not reducing our equity exposure. However, we are maintaining a high level of diversification, particularly on assets that couId help to protect portfolios in the event of further shocks.

As a reminder, we increased our exposure to gold in portfolios earlier this week and maintain our exposure to products linked to energy prices. For some of our risk profiles, commodities now make up close to 10% of portfolios.

 

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