Wars, like pandemics, can lead to changes in the global economic and financial regime. While it’s too early to tell how the Russia/Ukraine conflict will eventually affect economies and markets, a range of trends could emerge from this crisis that would have substantial investment implications. Here’s a framework for considering some of the most important potential macroeconomic and financial changes that could impact investors over the short and medium term.
The escalating Russia/Ukraine conflict threatens to push prices higher in two key areas: energy and food. A mix of risk premium, supply disruptions, and compositional demand changes (e.g., Germany tripling its LNG purchases) threaten to push energy prices higher. At the same time, Ukraine and Russia are both major agricultural producers. If consumer demand gets throttled while prices move higher, the growth/inflation mix could deteriorate, leading to stagflation — most notably in Europe but also in EM energy importers.
The conflict threatens to prolong the pain of the supply chain difficulties that have plagued the global economy over the past year. On the margins, airspace closures are shutting down cargo transit routes; Ukraine has also been blacked out as an exporter of cargo/equipment. In addition, Western sanctions are likely to generate a wide range of unquantifiable side effects that could further strain supply chains. These include Russia’s role as an exporter of key precious metals used for high-end electronics and catalysers; the effect of potential Russian retaliation, including cyberattacks; and financial and trade dislocations, with Russian trade curtailed or rerouted. These small system shocks would probably have a negligible effect in ordinary circumstances, but these marginal pressures may add up to a very meaningful effect on today’s stretched supply chains.
COVID-19 accelerated some global trends — including decarbonisation and deglobalisation of value chains — that have the potential to contribute to higher trend inflation. The Russia/Ukraine conflict may contribute an additional trend toward energy diversification. Furthermore, the conflict has added to deglobalization momentum through sanctions and geopolitics; expect re-shoring to finally gain some real traction. The potential re-armament of Western economies could pose a geopolitical headwind to capital markets as it could lead to inefficient capital allocation. Think of this as the expiration of the post-Cold War peace dividend, with increased costs of larger armies and non-productive arms stockpiles. All of these could together raise prices and curtail growth over the longer term.
The exclusion of some Russian banks from SWIFT — especially the Central Bank of Russia — would lead to series of dislocations in the financial system. One set of dislocations would be the direct result of unpaid claims or transfers, and their knock-on effects. Other dislocations would be indirect — e.g., financial transactions being deterred by worries over counterparty risk. Both would require that central bankers take action to ensure adequate liquidity. The longer-term after-effects of SWIFT sanctions might include the urgent development of an alternative payments system — likely by China. Such an alternative could see USD monetary dominance challenged by liberalised capital markets in China. In fact, the RMB is already behaving like a safe haven currency (as it did during March 2020).
To ensure the effectiveness of sanctions, unregulated areas of finance would likely need to be addressed systematically, meaning that any potential timelines for regulation of crypto currencies would accelerate. The “off-ramps” from crypto into fiat currencies would likely be made subject to regular anti-money-laundering and know-your-customer standards. Both supervision of the blockchain networks and approval of Stablecoin for use in settlement purposes are possible related actions.
The conflict in Ukraine and the world’s response to it have created a series of cascading shocks to economies, markets, and to the global geopolitical landscape. The human toll of this crisis is, of course, of foremost concern. As investors, we’re monitoring the situation closely and will regularly update our views on the investment implications of this crisis. For more information, please contact your State Street Global Advisors relationship manager.