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Ukraine crisis: what effects on stock exchanges and financial markets

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Ukraine crisis: what effects on stock exchanges and financial markets

By Raiffeisen Capital Management

For a long time, the tensions between Russia and NATO they have received little attention in the financial markets, except the Russian ones. This has changed dramatically in the new year. Every day there are new warnings of one alleged imminent Russian invasion of Ukraine, ever stronger sanctions are threatened by the US and the EU should such an eventuality materialize and military experts are increasingly sought after by many media outlets. It is speculated whether, when, where and how Russia could attack, with what prospects for success and what President Putin could do. The spiral of escalation – in both words and deeds – continues to be threatening on all fronts. What does this mean for financial markets around the world and especially those of Russia and surrounding countries?

Russia-Ukraine crisis: the current situation

Beyond diverging political assessments and expectations, there appears to be a broad consensus among all observers and practitioners that the situation is currently extremely dangerous, that it could spiral out of control and that the situation as a whole seems somewhat messy.
A diplomatic solution however, it should be possible, provided that all parties involved are fully aware of the gravity of the situation and of their responsibility. A continues escalation, which would ultimately lead to a direct military and economic confrontation, would have serious and hardly foreseeable negative consequences for Russia, as well as for Europe and Ukraine.
It remains to be seen how strong is the interest of the United States, as the main NATO power, in a compromise, given that the United States would hardly be affected by a possible escalation, at least directly.

The options of the Russian government

At the moment, no one can actually predict which options fly is considering and what are the probabilities of realization of each. We currently assume that a large-scale Russian invasion is not the main scenario and that it is not the preferred option by Putin. He would have little or nothing to gain, but much more to lose. However, if such a development were to occur, economic, political and financial sanctions by the West would not be long in coming.

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To date, however, the most likely options appear to be:

  • a compromise of some kind with subsequent “de-escalation” (best case);
  • a much more limited Russian intervention.

In the latter case, the West will probably react with new, drastic ones sanctions but it probably won’t enforce the full range – at least not immediately – if only to keep this option open. The concrete steps in this regard will naturally depend a lot on what Moscow actually does and on how the situation as a whole will present itself.
Consequently, any forecast for the financial markets is currently difficult or impossible. Positioning yourself for the worst case scenario makes little sense at the moment, and positioning yourself in advance of all conceivable sanctions, measures and scenarios is of course impossible.

Ukraine: the impact on financial markets

On a horizon of short term (three or six months), we see no reason to change our assessment at the moment baseline situation for global financial markets.

Russian stocks they do not have a significant weight in global equity indices and emerging market indices, so there are no major direct effects on this side.

Unless a global military conflict develops, the impact of any military confrontation between Russia and Ukraine it will most likely affect primarily the economies and financial markets of Russia, Eastern Europe and Europe in general. The direct consequences for other economies (and financial markets) are expected to remain relatively manageable and are likely to manifest initially mainly through energy prices.

The oil market he would likely pay an additional risk premium, but it is unclear how high this will be. Russia is not expected to drastically reduce its energy exports and Western sanctions in this direction have not yet been publicly challenged. OPEC countries (especially Saudi Arabia) could also mobilize additional capabilities relatively quickly.

On the other hand, the supply of natural gas in Europe would be more complicated. In the event of an escalation, there is the threat of further price increases and potentially supply bottlenecks. However, Russia has so far consistently denied that it wants to resolve the conflict at this level and a certain risk premium is already included in the current prices.

In addition to the direct fundamental level, there are of course sentimental and technical factors to consider in the financial markets.

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A stronger escalation with movements of risk-off around the world it is probable in the stock and bond markets, although some of these have already occurred.

Sentiment is bad enough and even very good business results are hardly taken into account at the moment. Furthermore in terms of the market, the picture has certainly worsened since the beginning of the year, although this is not only due to the Ukrainian crisis. Many market indicators (for example in the trend following) have moved to the sell or are in the process of doing so. In the end, the risk budgets of many investors seem increasingly exhausted and there is some stress in the market.

The stabilization of the technical framework will take some time. However, we don’t expect a major market crash at the moment. Here, too, we must keep the perspective: globally, shares have fallen by about 7-8% since the beginning of the year, after a previous increase of about 25%.

Therefore, so far we are moving in the range of a completely normal correction, which is not driven only by the Ukrainian crisis.

Portfolio: Prepare for all scenarios

The situation is tense and rather critical, but not hopeless. The price of a failure of diplomacy would ultimately be very high for all parties involved, although not equally high for all. In funds with direct exposure to Russia and Eastern Europe, we significantly reduced our positions, making them markedly more defensive.

It is impossible to be prepared for all possible diplomatic, political or even military scenarios. However, fund management is observing developments very closely in order to be able to react quickly and flexibly to changes in the situation if necessary. On the positive side, the talks and negotiations continue and all parties involved seem to be aware of the gravity of the situation and of their own responsibility.

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