How will the Russia-Ukraine conflict impact financial asset prices?

US stock market

In the early months of 2014, Russia annexed the Crimea region of Ukraine, claiming legitimacy for the move via a widely criticised referendum after the invasion. That episode created bouts of tension in financial markets, but nothing that really stuck. Stocks had the odd down day and the VIX index of stock market volatility soared on occasion, but there was nothing here that really knocked global markets out of their stride. But does that episode suggest that a similar, or even larger, incursion now would bring a similarly limit ed reaction?

Mr. Steve Barrow, Head of Standard Bank G10 Strategy doubts it. For a start, there’s the positioning and valuation of various assets to consider. For instance, in the stock market, while it is true that equities had been steadily rising throughout the Russia/Ukraine conflict in 2014, there had been no dramatic surge in stock prices as there has been in recent years. In short, it does seem as if risk assets like stocks could be more sensitive to a major geopolitical event now than they were eight years ago. Secondly, there is far more sensitivity to the potential rise in energy prices given the surge we have seen over the past year and, in particular, the rise in gas prices in Europe.

Russia supplies over half of Europe’s energy needs, and some countries have already been hit hard by gas price increases. A report from the International Energy Agency (IEA) last week accused Russia of under-supplying gas and thus contributing to the shortage that has lifted prices so dramatically. Governments in Europe are under pressure to compensate consumers for the surge in prices and, indeed, some authorities, such as those in Sweden, have already acted.

"Should a conflict between Russia and Ukraine materialise soon, we could clearly see gas prices spike dramatically once again, even if it is only a temporary knee-jerk reaction to the conflict. Presumably, other energy prices would spike in tandem, and this could unnerve financial asset prices in a way that is far more significant than what we saw in 2014. Safe-haven demand would increase for assets such as treasuries, the dollar, yen, and the Swiss franc. For gold prices, this is a harder one to call and probably depends on the extent of any dollar strength, for if the dollar soared, gold prices might struggle to see much benefit from this geopolitical tussle. Usually, when safe-haven demand lifts the dollar, the impact is felt most in higher-risk currencies, such as those in emerging markets. The euro, in contrast, is usually quite stable against the dollar during these episodes. However, here, with conflict right on its doorstep and energy prices a particular concern for Western Europe right now, we could see the euro under a bit more pressure than usual in such risk-off circumstances. Much could depend on how the ECB responds. There has been some argument within the bank recently that it should not see energy price strength as a transitory factor that won’t materially impact underlying inflationary pressure", Mr. Steve Barrow said.

Ukrainian soldiers on Jan. 17 traversed a trench near the front line in the Ukrainian village of New York, formerly known as Novhorodske.

Now, admittedly, that argument largely stems from the observation that climate change necessities could cause temporary or even longer-lasting shortages and price hikes in fossil fuel prices. Should any such shortages be exacerbated by geopolitical strains between Europe and Russia, it’s likely that the ECB will become even more sensitive to the possibility of an extended period of inflation and will seek to act accordingly.

Mr. Steve Barrow said, the situation is certainly not straightforward and, as he said at the top, we can’t be sure either that military action will result from the stand-off on the Russia-Ukraine border. But while conflict remains a possibility, we believe it is right to bias investment positions towards "safer" options, which means a preference for longer-dated bonds over stocks, and safe currencies for those of the "riskier" variety.