• War in Ukraine
  • 07 March 2022

Investment Strategy: War in Ukraine: The next chapter

War in Ukraine: The next chapter

US secretary of state Antony Blinken said on Sunday (6 March 2022) that the US and its European allies were discussing a possible ban on Russian oil imports to put further pressure on Russian President Vladimir Putin to end the war.

Any significant restrictions on Russia’s energy exports would represent a serious escalation of the sanctions applied so far to Russia and the latest developments move us closer to the downside scenario (Scenario 3).

In this update, we share our views on the latest developments and their implications for what lies ahead.

The struggle to keep the lights on: What would happen if Ukraine’s allies banned energy exports from Russia?

While Russia only accounts for less than 2% of global gross domestic product (GDP), it supplies 11% of global oil, 17% of global gas consumption, and as much as 40% of Western European consumption (as at end-2021). Sanctions targeting Russia’s energy exports would hit directly at the heart of energy supply for Europe, in turn affecting inflation and growth.

If the US, European Union (EU) and their allies decide to ban Russian exports of oil and gas, then crude prices are likely to trade towards their 2008 highs of USD150/barrel and, over the next few months, stay far above the USD80 levels seen at the start of the year.

In this situation, our current forecast for world GDP to expand by a strong 4.6% in 2022 – as economies keep reopening – would likely be revised down by almost a full percentage point to 3.7%.

The US would be less affected as it is more energy-independent than other major economies. China’s authorities would also likely be able to ease policy further, given low inflation in the world’s second largest economy, to defend the just announced official 2022 GDP growth target of ‘around 5.5%.’ But the Eurozone, UK, Japan, India, emerging Asia, sub-Saharan Africa and Latin America would all suffer from significantly higher energy costs. In the EU’s case, around 40% of its oil and gas supplies are imported from Russia. Moreover, Russia will also be strongly affected by the sanctions. Its economy is likely to contract by up to 10% this year, more than the 7.8% decline experienced in 2009 in the aftermath of the 2008 global financial crisis.

Russia supplies 11% of global oil and 17% of global gas consumption. Sanctions targeting Russia’s energy exports directly impacts European energy supply.

At the same time, inflation is likely to worsen. Thus, major central banks, including the Federal Reserve (Fed) and the Bank of England (BOE), are still likely to undertake a series of interest rate rises this year even as global growth prospects are hurt by surging energy prices. We anticipate five hikes by the Fed and four by the BoE in 2022, lifting the fed funds interest rate to 1.25-1.50% and the Bank Rate to 1.25% by year end, respectively.

With the Eurozone especially exposed to sanctions on Russian energy, causing European consumers to lose purchasing power, we expect the European Central Bank (ECB) will still only start raising its -0.50% deposit rate towards the end of 2022. The ECB’s cautious strategy will help accommodate the negative impact of higher energy prices on Eurozone growth. But the EUR will likely stay weak in the near-term as the Fed and BOE – by contrast – steadily increase interest rates this year.

If global growth falls from last year’s five-decade high of 6.0% in 2021 to 3.7% in 2022 – rather than our current base case of 4.6% – and global inflation increases further owing to higher energy costs, then the world economy will face a ‘stagflationary’ shock. But we note that while global growth this year would slow sharply compared to last year, it would still be well above the 3.0% average annual rate recorded by the world economy since the modern era began in the 1970s. Thus, global activity would still be firm by historical standards with the ongoing recovery from the pandemic preventing growth stagnating throughout the year.

Implications for commodities, FX, fixed income and equities

Scenario 1:

Tough but calibrated sanctions on Russia that leave its energy exports intact; ongoing resistance to the Russian invasion within Ukraine, supported by its allies.

Macro/FX/Commodities:

  • Global economic recovery continues and major central banks stay on course to gradually tighten monetary policy.
  • Oil shock avoided but spillover from high European gas could keep oil prices elevated in the near term. As oil prices ease below USD100/bbl by 2H22, stagflation worries should fade to the detriment of gold.
  • Drag on the EUR will be brief and minor.

Rates/Fixed Income:

  • Credit spreads remain elevated while energy prices stay high in the near term.
  • Cautious positioning in global fixed income with preference for Gulf Cooperation Council (GCC) investment grade credits and high-quality corporates.  

Equities:

  • Sell-offs to present opportunities for longer-term investors.
  • Value/cyclical sectors such as Financials, Energy and Industrials to outperform over longer term, supported by underlying economic and earnings growth and rising interest rate trajectory.

Scenario 2:

Quick ceasefire and resumption of negotiations.

Macro/FX/Commodities:

  • Global economic recovery continues and major central banks stay on course to gradually tighten monetary policy.
  • Oil prices quickly ease back below USD100/bbl. Gold prices decline on the back of a resilient global economy and a hawkish Fed.
  • Prospects of Fed tightening and the hawkish turn from the ECB point to both stronger USD and EUR against the JPY.

Rates/Fixed Income:

  • Market attention shifts away from the conflict and towards other macroeconomic concerns, namely inflation and rates. Buying opportunities in select global credit, as spreads have significantly widened in the space.
  • African credit benefits as attractive diversification within CEEMEA, while Mexico and Colombia benefit from relatively high oil prices.

Equities:

  • Equity markets to heave a sigh of relief from the alleviation of tensions, and investors’ focus will again return to underlying earnings recovery of companies and tightening of central bank policies. 
  • Maintain value/cyclical tilt as global economic recovery continues with the transition of the Covid-19 pandemic to endemic status.

Scenario 3:

Protracted war and severe sanctions, including targeting of Russia’s energy exports; potential influx of war refugees into European Union.

Macro/FX/Commodities:

  • Global growth slows, oil prices spike towards USD150/bbl and stay higher for much longer as sanctions disrupt Russian energy exports.
  • Gold prices surge past USD2,000 to revisit historical high on escalating stagflation risk and prospects that Fed normalisation could be cut short.
  • Conflict proximity and drag from high European gas prices could stall ECB exit from quantitative easing and weigh heavily on the EUR. Stronger USD and JPY on protracted risk aversion.

Rates/Fixed Income:

  • New sanctions impact energy exports from Russia, prolonged risk-off leads to further credit spread widening while US Treasuries rally (yields fall).
  • Higher energy prices hurt global growth. Beneficial for safe-haven fixed income positioning in GCC investment grade credits as well as high-quality Chinese state-owned enterprises with energy exposure.

Equities:

  • Though a spike in energy prices is supportive of the Energy sector, if this is sustained without a corresponding supply response from other energy producers, prolonged high energy prices would threaten economic growth and result in demand destruction, which is negative for cyclical sectors such as Consumer Discretionary.

The situation remains fluid, but some sectors stand in better stead than others: Depending on the severity and duration of the final form of sanctions, we may moderate our current value/cyclical tilt amongst our sector preferences. Sustained high energy prices would also increase the incentive for businesses to pivot more towards renewables, benefiting certain companies in the Industrials and Utilities sectors. On a geographical basis, countries that are more energy self-sufficient and have higher reserves would also be better positioned to ride out an energy crisis. On a broader market perspective, we currently prefer Asia ex-Japan from a regional equity allocation perspective, relative to the US, Europe and Japan.

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