Russia's attack on Ukraine is already over two months old. Many market participants seem to have gotten used to the situation. But does this mean everything is now back to how it was before the invasion? Hardly, Gérard Piasko writes in an essay on finews.first.

This article is published on finews.first, a forum for authors specializing in economic and financial topics.

Although one would hope that the war will end quickly, it is probably more likely that it will continue for a longer period. It could even escalate further, which may trigger a stepping up of sanctions and place more pressure on risk-oriented assets such as equities.

An escalation of the conflict would exacerbate the situation and see the risk of stagnation move towards a risk of recession. Due to Europe’s energy dependence, the EU would be more impacted than the U.S. or Switzerland, where only around 7 percent of the energy supply comes directly from Russia. In some EU countries, this figure is in excess of 50 percent.

What might be the economic impact of a prolonged conflict without any further escalation?

As around 30percent to 40 percent of European gas and oil imports come from Russia, energy prices would likely remain at historically high levels over an extended period, apart from sporadic consolidations. This would also be the case with deliveries of additional, albeit insufficient, liquid gas from the U.S. or Qatar.

«This would lead to increased political pressure on the U.S. Federal Reserve»

Such a high level would lead to price increases and perhaps also temporary interruptions in industrial production in various countries. It would also keep global inflation too high for the central banks’ liking for a longer period. In this case, inflation in the Eurozone would likely be 1.5 percent to 3.5 percent higher than it would be if the war were to end or if there was a clear de-escalation in hostilities.

In the emerging markets and the U.S., producer, and consumer price inflation could be 1 percent to 2 percent higher than prior to the war. This would lead to increased political pressure on the U.S. Federal Reserve (Fed) to push ahead further with rate hikes.

«Global economic growth could weaken»

Depending on the development of real interest rates, this could lead to additional burdens for both bonds and equities. As global economic growth would then likely be lower, defensive bonds and equities, i.e. less cyclical securities, would be in greater demand.

Global economic growth could weaken by 0.75 percent to 1.75 percent in 2022 due to the Ukraine war, with this figure standing at around 0.8percent in the U.S., 1.5 percent to 2.5 percent in the EU, and 0.5 percent to 0.75 percent in China and Switzerland.

On the one hand, the reason for this is slower growth in industrial production due to higher transport and commodity costs as well as temporarily increased supply problems. On the other, disposable income for consumption and the purchasing power of consumers is falling against the backdrop of persistently high commodity and consumer prices by historical standards.

«Sales growth is likely to also visibly decline in the event of a prolonged war»

Growth in corporate earnings would also decline relative to the existing market consensus expectation, a development triggered by margin pressure from rising commodity, wage, transport, and financing costs as market interest rates increase.

However, sales growth is likely to also visibly decline in the event of a prolonged war if the situation becomes gloomier with respect to consumer sentiment and the business sentiment of entrepreneurs, meaning that even corporate investments are hit.

«This argues in favor of a clear focus»

This could be countered with renewed financial stimulus from governments (especially in the EU) or postponed rate hikes. Until this is decided, we anticipate an above-average level of volatility in the financial markets for an extended period.

The probability of a prolonged conflict in Ukraine, with or without escalation or the imposition of further sanctions against Russia, argues in favor of a clear focus on defensive quality in the sense of more stable profitability, the ability to charge higher prices to end customers thanks to a good market position (in order to offset higher input costs) and lower economic dependence due to the increased risk of a marked weakening of global economic growth.

Gérard Piasko was appointed chief investment officer (CIO) at Zurich-based private bank Maerki Baumann in early 2018. He is responsible for the investment strategy of the bank and the communication of its asset allocation vis-à-vis clients. For many years he was the private banking CIO at Julius Baer, Bank Sal. Oppenheim (Switzerland) and, most recently, Deutsche Bank (Switzerland). He studied economics and law at the University of Zurich and achieved a postgraduate diploma from Columbia University in New York.

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