The market implication of escalation in Ukraine

Markets are considering the implications of Russian sanctions and a potential spike in gas prices, as the conflict in Ukraine intensifies.

| 11 min read

Please note this page will be regularly updated on the market impact as events change.

Ukraine: Russian troops move in

24th February 2022

Russia has invaded Ukraine. In a pre-dawn TV statement, Russian leader Vladimir Putin said Russia did not plan to occupy Ukraine and demanded that its military lay down their arms.

After weeks of building up large forces near Ukraine and listening to western leaders, Vladimir Putin is now in a hurry. As we suggested yesterday, his aim seems to be to secure regime change in Kiev and insist on Ukrainian neutrality, a way of describing a Ukraine that bends to the Russian will and looks more towards Moscow for economic ties and political leadership. He says he is not about to launch a major invasion with a view to imposing Russian military rule.

So far, reports claim Russia is trying to damage Ukrainian military installations and equipment to limit Ukraine’s ability to fight back. In Mr Putin’s warped logic, he would also take any Ukrainian military response as a “provocation” justifying more direct Russian military engagement. The troops and weapons are close by and may be deployed if and when Mr Putin thinks he has a pretext and an opportunity to further his aims.

Markets have sold off in Asia and oil has risen again in price.

No action from NATO

US President Joe President Biden and NATO are confirming today that they will not undertake any direct military response to this attack on an independent country near their borders, but will meet to intensify sanctions. The UN has condemned the actions of Russia. Markets have sold off in Asia and oil has risen again in price. The possible disruption of energy supplies and the likelihood of tougher sanctions affecting international trade and payments involving Russia needs to be fully discounted. There is also knock on from higher energy prices to the western inflation problem which could also affect future central bank policy.

Ukraine is threatening to fight any invasion force but is also seeking to demonstrate that it has not launched any attack on Russian forces beyond its borders nor against rebels in the Eastern provinces. It both wishes to avoid feeding Mr Putin’s twisted narrative and to make it clear to Mr Putin a full-scale invasion and attempted military rule would produce strong resistance. None of this is helpful background for economies and markets, and there is no good resolution in sight this morning.

Markets take stock of Ukraine

23rd February 2022

Markets are considering the implications of Russian sanctions and a potential spike in gas prices, as the conflict in Ukraine intensifies.

As we expected, Russian President Vladimir Putin wishes to prolong and extend the conflict in East Ukraine. His decision to recognise the two rebel provinces of Luhansk and Donetsk contains the seeds of further dispute. Russia may now be sending troops into these two areas as self-styled peacekeepers, reinforcing the rebel forces against the Ukrainian state.

Russia has recognised the entire area as independent of Ukraine, which goes beyond the borders so far established by rebel forces in the long-running civil war there. Russia is increasing pressure on the Kiev government to retaliate with military action, which would then give Russia a bigger excuse in its own world view to intervene with substantial forces on behalf of the rebel forces defending the newly-recognised states.

Map 1: Ethnolinguistic map of Ukraine with contested areas and major gas pipelines

Germany halts Nord Stream 2

We have now seen the first phase of the US and NATO response. As promised, they have opted for a range of sanctions against individuals and banks and have made clear there will be more to come if Russia intensifies its military action against Ukraine. US President Joe Biden has confirmed he did not make a mistake when he previously said the response would be less to a limited incursion, though his staff moved fast at the time to contain the damage that statement caused. It would be seen as reassuring by Mr Putin when contemplating how far he could go in seeking to annex parts of Eastern Ukraine.

Germany remains very dependent on large quantities of imported Russian gas.

Germany finally announced that it is putting on hold its consideration of giving the go-ahead to the Nord Stream 2 gas pipeline. Germany has been reluctant to do this – and is still not ruling out resuming its regulatory consideration preparatory to signing contracts at some date in the future.

Meanwhile, Germany remains very dependent on large quantities of imported Russian gas coming by other pipelines, which still have the capacity needed for current volumes. Russia issued a tweet threat that gas prices could well double from an unstated base to remind Germany of its vulnerability. It would suit Mr Putin well that Germany carries on taking the gas at higher prices, allowing Russia to build its war chest of money from fuel. It also still leaves open the more extreme option for Russia to interfere with the supply or cancel contracts were the western sanctions to become too damaging.

Full-blown war unlikely

We remain of the view that there will be no NATO-Russia war as a result of events in Ukraine. NATO is busily reinforcing defensive positions in eastern NATO states but is not sending military forces into Ukraine to help defend the territory there. Ukrainian membership of NATO is still not being entertained, so Ukraine continues to lack a NATO pledge to defend it against aggressors. It is NATO’s presence in Estonia, Latvia, Lithuania and other places close to Russia that worries Mr Putin most, as he will not accept that NATO is only a defensive alliance, with no aggressive plans against neighbouring countries.

Map 2: NATO expansion

Ukraine is the current centre of his interests, just as he has intervened in Georgia and has cemented relations with a more friendly Belarus

Mr Putin’s aims are likely to be twofold. He wishes to show Russia is a serious force in the world. He likes all the attention and summitry the Ukraine conflict brings to him. He also wants to recreate as much influence and Russian territory as possible in the ring of buffer states that lie to the west of Russia that were part of the old Soviet Union. He recognises that he has more scope to take over, subvert or split those countries near to Russia that are not NATO members.

Ukraine is the current centre of his interests, just as he has intervened in Georgia and has cemented relations with a more friendly Belarus. He may well wish to see the end of the Kiev government, and his pressures to split the country will be part of a strategy to maximise difficulties for the current administration. He would like to reverse the removal of the fourth President for being too pro-Russia in 2014 by finding a more friendly President of a possibly neutral Ukraine. He still has the option of a widespread invasion of Ukraine as a whole, knowing there is unlikely to be a NATO response involving NATO personnel, but is likely for the time being to stoke the civil war in the Donbas and collect the extra gas revenues.

Risks for Russia

The invasion option has plenty of downsides for Russia, as the Ukrainian forces could inflict substantial damage on a Russian invasion force, and the people of Ukraine would not take kindly to attempted military rule from Russia.

The most likely outcome from here is continuing civil war in East Ukraine, continued tensions that sometimes spill over into markets and continued pressure against the Kiev government. The economic impact will be felt mainly through higher energy prices and whatever additional damage further sanctions might do. Markets are still more likely to be driven by inflation and central bank responses to it.

The Russia-Ukraine crisis- Market impact

22nd February 2022

Markets are reacting day-to-day to better or worse news from this conflict. It seems likely the troubles in Ukraine are becoming part of the unpleasant backdrop to European politics. The knock-on effect to markets comes through sanctions. Were the West to impose very severe sanctions, effectively banning Russia and Russians from the western banking system, there would be a cost to the West.

Russia has decent foreign exchange reserves and may have a side deal with China to work with them over financial matters in the event of tough sanctions. Russia also has the gas weapon and has been exploring the possibility of selling more of its gas to China. If the West’s sanctions went too far, allowing Russia to claim contract breaks over gas, the continent would be in a difficult position as it needs Russian gas to heat homes and keep factories turning.

Past limited regional conflicts have hurt markets when they break out but often led to sharp recoveries as people get used to the idea that these unhappy events will nonetheless not make much difference to the global market system. This one, however, takes place against a different general background, where the main central banks are all tightening to try to control a nasty inflation. This will limit the ability of markets to respond bullishly to any reduction in perceived risk in Ukraine and increase the willingness of the market to be pessimistic if or when the conflict takes a turn for the worse.

The commercial threats revolve around two main ones. If it leads to reduced oil and gas supply from Russia another twist could be given to the energy inflation. If the banking sanctions go too far there could be settlement and security issues from past commitments to Russian activity and money.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

The market implication of escalation in Ukraine

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