Rising tensions between Russia, Ukraine and NATO[i] have the world on edge, and many investors appear to be concerned. A major geopolitical event can send shockwaves through financial markets. However, predicting the behavior of global leaders can be difficult for even the most seasoned foreign policy experts. Here, we look at three scenarios and how those potential outcomes could impact financial markets.
A frozen conflict
Russia, Ukraine and NATO could stay in a frozen conflict, with no party making a move that would significantly escalate the situation. We think this scenario would maintain the status quo, with no additional impact to financial markets or changes in government or central bank policy.
A partial invasion
In our view, a partial invasion would involve Russia making a land grab in Ukraine and/or initiating an aggressive cyberattack against the country or its allies. In this scenario, we think the US will likely apply some sanctions to Russia. The potential European response is less clear, since many European countries have economic interests in Russia and desire for constructive relations with the country.
We believe markets would have a strong risk-off reaction and then normalize quickly once it’s clear a full invasion is not underway. We would expect a short-lived rally in US Treasurys and the US dollar. In our view, the euro might take a modest hit on risk sentiment, but the currency’s fundamentals should support it longer term. Energy prices would likely spike, with a further rise if energy is included in sanctions. In this scenario, we believe the Federal Reserve and the European Central Bank would stay on course, cautiously removing financial accommodation.
A full invasion
If Russia launches a full invasion of Ukraine, we expect more severe sanctions from the US and NATO. In the US, we think Congress would likely move away from the Build Back Better budget in favor of a bipartisan agreement that would raise spending on military and cybersecurity, including a possible tax hike.
We believe markets would have a strong risk-off reaction, with a flight to perceived “safe harbor” assets like US Treasurys and the US dollar. The euro would likely take a temporary hit. In our view, a full invasion would trigger a severe spike in energy prices. We also see a possible impact on aluminum, titanium and uranium prices if Russia uses these commodities for leverage against the West.
In this scenario, we believe the Fed could temporarily delay its initial rate hike. The ECB might step up bond purchases if there is an impact on credit spreads, but any action would be the result of market behavior rather than fundamental deterioration in our view.
Russia retains significant leverage against the West
Whatever the outcome, we think it’s important to remember that Russia currently has significant leverage against the West and plays a critical role in the global supply chain beyond oil and gas. The Russian state owns a significant stake in VSMPO-AVISMA, a Russian company that represents more than 30% of the global production of titanium. This company produces approximately 65% of Airbus’s titanium consumption, 35% of Boeing’s and the entirety of Brazilian company Embraer’s.[ii]
Russia’s leverage is not limited to commodities produced within its own borders. Moscow retains enormous influence in other post-Soviet states, including Belarus and Kazakhstan. Belarus is not only a major producer of potash and other commodities, but also home to BelAz, a Soviet-era manufacturer of the largest heavy trucks in the world, used by mines globally. Kazakhstan is a central player in numerous commodity markets, boasting the largest reserves of zinc, tungsten and barite in the world. Kazakhstan also accounts for nearly a quarter of global uranium production, the second-largest reserves in the world.
We believe markets may be underappreciating Russia’s role in these global supply chains. We will be watching this area closely as the situation evolves. For a deeper dive into this topic, read Senior Sovereign Analyst Hassan Malik’s paper, “Consider the Less Obvious Dependencies on Russia.”
Darcie Sunnerberg, Associate Director, Macro Strategies
Brian Horrigan, Chief Economist
Saurabh Lele, Senior Commodities Analyst
Jon Levy, Senior Sovereign Analyst
Hassan Malik, Senior Sovereign Analyst
Ramsey Andrawis, Macro Strategies Research Analyst
[i] North Atlantic Treaty Organization
[ii] Kommersant, 15 November 2021.
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