Russia-Ukraine one year on: Contained but not over

Executive summary:

  • What was avoided and what are the ongoing threats
  • Potential scenarios on the horizon as spring approaches
  • The role of geopolitical relations in the outcome and investments implications
Contained, but not over

Russia’s invasion of Ukraine on 24 February 2022 shocked global investors, put the post-lockdown economic recovery into question and escalated geopolitical tensions.  A year on, it’s worth assessing the impact so far; what didn’t happen and where the threats are.  Many of the worst fears – global recession, sustained inflation, wider conflict – have not been realised. The war has moved closer to stalemate and energy prices have cooled. The risk of further escalation remains, however, and the war has worsened the longer-term geopolitical tensions between the West and Russia/China. 

What didn’t happen

There were fears after the invasion that the war could spread to a neighbouring NATO country such as Poland or Slovakia. This would trigger Article 5 of the NATO agreement which holds that an attack on one NATO member is an attack on all members. There were also concerns about a nuclear event in Ukraine. This almost eventuated with the attack on Europe’s largest nuclear power plant at Zaporizhzhia in early March. There has also been the ongoing threat that Russia will deploy small scale tactical nuclear weapons on the battlefield. Thankfully, none of these have occurred, but remain risks as the war drags on.

There were also concerns that the invasion would derail the post-Covid-19 global economic recovery. The main channel was higher energy prices through Europe’s reliance on Russian gas, and Russia’s role as a major exporter of oil. There were also worries about a spike in food prices given Ukraine’s status as a major exporter of wheat and corn. 

Russia-Ukraine war commodity price tracker

Click image to enlarge

Source: Refinitiv Datastream, 22 February 2023.

Energy and wheat prices spiked in the months following the invasion but have since returned to near pre-invasion levels. The inflation pressures caused by these price spikes have made the major central banks more hawkish, but the overall impact on economic growth has so far been relatively limited. The biggest surprise is that Europe has avoided recession. Before the invasion, Europe relied on Russia for 40% of its natural gas and 20% of its oil supply. The unusually warm winter in Europe meant that energy rationing was avoided, and European governments have also moved quickly to diversify away from Russian energy dependence. Next winter will provide another test, but Russia’s energy weapon against the west has so far been relatively ineffective. 

What happens next?

Predicting the outcome of the war is a foolish exercise and so far, neither side has been able to gain a decisive advantage. It’s possible that the war heads towards stalemate after renewed conflict over the summer. The role of Ukraine’s western allies and Russia’s main partner in China will be important. How much additional support in terms of military hardware will the United States and Europe provide to allow Ukraine to regain lost territory? Will China provide substantial military support to help Russia prevent a comprehensive defeat? Can there be a negotiated settlement that saves face for Russia whilst allowing Ukraine to retain most of its territorial integrity? It will be a test of whether the US and China are able to work together to preserve the geopolitical status quo, or if Russia/Ukraine becomes a proxy battlefield for the two global powers.

So, the geopolitical power balance is likely to be the most significant implication of the war over the next year.

Investment implications

The main investment lessons are to acknowledge the role of uncertainty in market outcomes and reinforce the importance of avoiding overconfidence. Confident predictions of a rapid Russian victory, a European recession and a sustained global energy shock have been incorrect. The impact of the war on global economies, central banks and markets has been more complex than most forecasters anticipated. The war has demonstrated once again that investors should be careful not to over-react to seemingly dramatic events. The best defence against uncertainty and unexpected shocks is a well-diversified portfolio that is based on a rigorous strategic asset allocation.