Escalation of the conflict between Russia and Ukraine: are the markets at risk?

What has happened in recent days?

The tensions between Ukraine and Russia continued to keep the global markets in suspense on Monday. Russia has so far defied any diplomatic attempts by the West to strengthen the armistice in Donbas and to continue negotiation in order to prevent the crisis from escalating. Instead, President Putin announced after a meeting of the Security Council of Russia that he would officially recognise the separatist areas in Eastern Ukraine. His instruction to the Ministry of Defence to send “peacekeeping forces” (© President Putin) to the rogue regions escalated the situation further.

The European equity market was hit by these developments on Monday, incurring clear drastic of 2.2% (EuroStoxx 50). The oil price increased substantially, and gold was in high demand as well as safe haven. The Asian trading session on Tuesday resulted in noticeable losses, with futures contracts on the US stock exchanges suggesting lower opening levels after the national holiday in the USA.

Apart from the Ukraine crisis, the recent economic data have been positive. In Europe, the purchasing managers’ indices were published yesterday, exceeding expectations significantly in particular in the service sector.

Only negotiation tactics?

Despite the step taken by the Russian government today, the degree of escalation is currently below that of an open conflict and can be seen as high-pressure negotiation tactics. Western heads of state and government have threatened a strong response to any form of recognition of the separatist republics and will probably impose sanctions and other measure against Russia. 

On Tuesday, the focus is on the impact of the recognition of both areas with respect to the military help provided by Russia to the separatist republics and the penal measures taken by the West.

Possible scenarios from the perspective of Erste Asset Management

From our perspective there are currently two major scenarios:

1. The new situation has created a fragile stalemate that is defined by initial “commensurate” sanctions of the West against Russia in order to be able to maintain the threat of harder sanctions. In this scenario, the door would remain open for diplomacy, which could contain the damage for the global economy.
2. The recognition could be a springboard for a larger invasion of Ukraine by Russian forces, which Western heads of state and government have warned against in recent weeks (above all, Joe Biden and Boris Johnson). This could lead to hard sanctions against Russia and result in more severe effects on the global economy.

In both cases, we expect volatility to remain high on the markets. Also, the more restrictive measures announced by central banks in recent months could be pushed back at least in part.

In our funds and portfolios, we stick to the positions that we have communicated over recent weeks for the time being.

CONCLUSION:

The Russia/Ukraine conflict is keeping the markets in suspense. Everything is possible – from continued diplomacy in order to contain the escalation to harder sanctions in case of a more comprehensive invasion. The volatility on the financial markets will remain high.

Legal note:

Prognoses are no reliable indicator for future performance.

 

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