Will the euro be vulnerable if a peace deal in Ukraine fails?

First it was tariffs; now it is the war in Ukraine. Financial markets have been moved back and forth by bouts of optimism and pessimism on tariffs and it looks as if the fate of the war in Ukraine could create similar volatility. In the end, it looks as if US tariffs are coming and, as for the war in Ukraine, we doubt that it will come to an end anytime soon.

There seem to be innumerable reasons why current efforts to forge a peace deal will fail. The first, and most obvious one, is that any ‘deal’ that seems to exclude one of the protagonists (Ukraine) to a significant extent is bound to fail. The only way that a peace deal ostensibly agreed between the US and Russia could work is if the authorities in Ukraine thought that they were on the brink of losing the war, and that does not seem to be the case. The second, and related reason, is that even if Ukraine is heavily involved in peace discussions down the line, it is clear that the ‘deal’ that will be offered will be one that looks close to being a Russian ‘win’. And the third primary reason is that the ‘cost’ of securing peace for Ukraine, which seems to be giving up a half of its critical minerals to the US, seems too high.

It might well be the case that the US and Russia agree to a ‘deal’ and then present it to Ukraine (and the EU) as a fait accompli. This is likely to be rejected by Ukraine at a cost of the US pulling support for the country. While this might seem a very high cost, it already seems inevitable that the Trump administration will not sanction any new support packages in the same way that former president Biden had been doing. Will Ukraine lose the war if the US stops funding? President Trump might have claimed that the US has contributed much more to the war in Ukraine than the EU, but that’s not true at all.

However, it has still contributed greatly, and especially through military equipment relative to the equipment that the EU has provided. If US support stalls as a result of the failure of Ukraine to agree to a US-Russian peace deal things will undoubtedly become far harder for Ukraine. The nature of the war has changed somewhat over the past three years. For while there might have been the original view that the country with the most troops and most military hardware, like tanks, would prevail, putting Russia as the favorite, the vastly increased use of low-cost drones by Ukraine to knock out expensive Russian military hardware has rather evened the balance.

A second point is whether Europe will step up to bridge any gap left by the US. The recent rise in bond yields in the euro zone partly reflects speculation that countries will have to do this and so borrow far more heavily, whether individually or through a common fund. Does this imply that the war could just continue for as far as the eye can see? Possibly. Perhaps more likely is that a peace deal will be achieved in the future, but one that is not constructed on the US’s terms and hence does not involve Ukraine handing over vast swathes of its critical minerals to the US. But that could still be some time off.

How will financial markets react if things play out in this way? Disappointment over a failed attempt at a peace deal could drive an even bigger wedge between the EU and the US administration. This could induce retribution from the US that goes beyond pulling Ukraine funding, such as even steeper tariffs. A schism between the US and EU over Ukraine would likely weigh on general financial market sentiment and possibly turbocharge the drive for safe assets.

In terms of the FX market, we could see non-European ‘safe’ currencies gain. Here the Standard Bank is thinking about the yen. Will the euro be particularly vulnerable to a failed peace deal? It could be, although the nature of the peace discussion so far and the modest way that the euro has risen on peace hopes leaves us feeling that the market is sceptical about a deal, and hence this bank doubts that the euro will crater if a deal falls apart.