Russia-Ukraine crisis: Sifting through the consequences

Russian president Vladimir Putin announced military operation in Donbas region.

Financial market prices are glued to the Russia/Ukraine standoff. And while other factors, such as the surge in global inflation, will surely be of far more importance in time, there’s no getting away from the fact that the Russia/Ukraine spat dominates now. But is it just a case of weathering the uncertainty, or could a full scale war impact markets for some time to come – and how?

Mr. Steve Barrow, Head of Standard Bank G10 Strategy argues that there are, perhaps, three main ways in which a conflict in Ukraine could impact global markets. The three relate to the impact of a war on energy prices, on those that have lent to Russia and on the risk of a Russian cyber-attack. Of the three, it is arguably the first, energy prices, that have garnered the most attention so far and perhaps rightly so given that surging prices to date have already exacerbated the global inflation problem enormously.

Many European countries, especially Germany, are in the forefront of such concerns given that there is hefty dependency on Russian gas supplies. Indeed, the lack of cohesion in the EU’s response to the threat of war came because of energy-related political divisions within the bloc. Should Russia invade and energy prices surge it will add to the stagflationary concerns that have been rather under the radar before now.

Central banks could respond to the threat of even higher inflation by tightening policy more quickly but the ECB, for one, has always tried to look through surging oil prices if at all possible. Could it even mean a postponement or slowing of policy tightening should fears of economic contraction dominate any inflationary angst? The answers to these questions will have a big role to play in how the bond market responds to any invasion.

Right now, the market seems very unsure as the prior inflation-related rise in yields has now stalled. “Whilst an invasion by Russia seems likely to prompt a knee-jerk fall in yields, particularly in treasuries, we doubt it would persist. And even if any initial surge in energy prices quickly evaporates, we’d still suggest that yields will rise over time for, as we said earlier, the dynamics of the global inflation problem and policymakers’ response to it are more important over the long haul than any Russia/Ukraine conflict”, Mr. Steve Barrow said.

A second issue to look out for, should Russia invade, is the impact on Russian finance via the sanctions that the West would quickly impose. The international lenders most exposed to Russia lie in the EU, notably Italy and France. US creditors to Russia, for instance, only have around 60% of the exposure of France and Italy – and clearly much bigger banking systems to shoulder the burden. The UK’s exposure is just 12% of that seen in Italy or France. Consequently, it will be European banks that are targeted should there be any question at all of Russia being able to meet its international obligations.

“We have seen some of this vulnerability already. We suspect it will be contained even on an invasion by Russia, particularly if the country is not locked out of global payment systems by sanctions from the off. Nonetheless, it might be worth watching the development of credit and government bond spreads within the euro zone, particularly given how spread divergence over bunds has been growing quite sharply”, Mr. Steve Barrow stressed.

The final aspect is cyber warfare. It is believed that Russia has been behind numerous attacks on the West in the past. Of course, there’s no way of knowing whether such attacks would escalate, or would be any more successful in the event of an invasion of Ukraine, but it is definitely something to be borne in mind even if it cannot be anticipated in advance.