The Russian invasion of Ukraine has triggered a global shockwave.
First and foremost at a humanitarian level. After more than 15 days of armed conflict, the toll is already extremely heavy with the loss of several hundred lives and immeasurable suffering inflicted on civilians in the country. According to the United Nations High Commissioner for Refugees, over two million people have left Ukraine. We express our deepest sympathy and solidarity with the victims of this armed conflict.
At the same time, we should also consider the war’s economic and financial consequences.
The global equity market has fallen by just under 10% since the start of the year. But there is a strong disparity in performance both geographically (underperformance of Europe / outperformance of emerging market countries, driven by Asia and Latin America) and in terms of sectors (underperformance of consumer cyclicals and IT / outperformance of energy).
The correction of risk assets is mainly due to fears of a sharp slowdown in growth coupled with high inflation. The spectre of stagflation is resurfacing, particularly in Europe. Such a scenario will have a knock-on effect on corporate earnings. In this anxiety-ridden environment, risk premiums are rising. Measured by the VIX index, volatility has surged, reaching its highest level since the beginning of the year.
Safe havens – such as gold and US sovereign debt – have duly played their shock-absorber role since the outbreak of hostilities in Ukraine and are performing well.
Global growth outlook downwardly revised
The prospects for global growth will be revised downwards. However, it is impossible to estimate the extent of this revision right now. It will depend on the duration of the conflict, the economic consequences of international sanctions against Russia, possible retaliatory measures by Russia and, above all, what happens to commodity prices.
The release of the leading PMI and ISM indicators in the coming months should provide a preliminary indication of the extent of the deterioration in the global economy. Europe will be particularly affected and a recession cannot be ruled out given the region’s heavy dependence on Russian energy. By way of illustration, around 40% of European gas consumption was supplied by Russia in 2021. The US and Chinese economies are likely to be considerably more immune.
Inflation rising rapidly
The scenario of a rapid decline in inflation is now out of the question. The explosion in energy prices – and commodity prices in general – is bound to drive up inflation figures over the coming months. Gas prices in Europe are already up by more than 100% since the beginning of the year. Brent crude, the benchmark for the North Sea oil market, is up by over 50%. These increases will have a negative impact on confidence, particularly among consumers, who will suffer a significant loss of purchasing power. In the US, inflation rose to 7.9% in February, its highest level since the early 1980s. In the eurozone, prices increased by 5.8%. The current context is in many ways comparable to that of the 1970s following the two oil crises.
Central banks ambushed
At this stage, less accommodative monetary policies are still in place, especially in the US. Tighter financial conditions (including higher equity risk premiums and widening credit spreads) are not expected to significantly alter the move to raise interest rates in the US. The markets are now pricing in 5 to 6 rate hikes by the end of 2022. In the eurozone, the first increase in the cost of borrowing is expected by December 2022 but will clearly depend on the changing dynamics of the European economy A significant deterioration in the European economy would almost certainly crush any inclination to tighten the ECB's monetary policy.
Article by
Damien Petit, Sales Director, Private Banking, Banque de Luxembourg
To find out more about how to invest in this environment, contact a private banker.
