Russia-Ukraine war, the risks of a new economic crisis at the gates: the report
There crisis between Russia and Ukraine hangs over commodities this week, with markets hovering over potential responses from the West. There Russia is a major exporter of energy through the gas, oil, and coaland is important in aluminum production as well nickel. But a cut of the supplies of gas or gas or coal Russia’s thermal on both sides would be very damaging to Europe and could threaten a global recession.
The effects of any cut in Russian exports of aluminum and nickel could potentially be mitigated by the Russia-China alliance. There China is the largest importer of raw materials, so the main impact would likely be to increase the voltage in Europe and in United States. That being the case, we expect an outbreak of hostility to lift commodity prices on supply concerns.
THE commodity prices on supply concerns, but if export cuts are not announced, commodity prices could subsequently slide as markets weigh the likelihood that hostilities and countermeasures will drag global growthpotentially in recession
Ukrainian war, sanctions on Russia: the ruble sinks
More sanctions on Russia, announced by the West over the weekend, caused the ruble to plummet on Monday. The penalties include the exclusion of some Russian banks from Swift and also target the central bank of Russia (CBR), with the United States banning transactions with the CBR. The central bank’s freezing of foreign exchange reserves targets the CBR’s ability to defend the ruble with its foreign exchange reserves.
While the CBR has decreased its USD reserves in recent years, it still holds a large part of its reserves in EUR and to a lesser extent in GBP (Figure 1). Its gold and CNY reserves are of limited use to defend the ruble on the dollar market. It will become increasingly difficult for the CBR to sell its gold for hard currency
For the first time in years, the CBR stepped into the FX market last week to support the ruble. This may, to some extent, explain the rather subdued movements of the ruble last week, which were comparable in scale to what occurred during the 2014 Crimean crisis. However, as mentioned, the sanctions make it difficult for the CBR to sell its foreign currency for the local currency, which limits its ability to support the ruble through such measures.
In an emergency meeting on Monday morning, the CBR raised its base interest rate from 9.50% 20% before the market opens. A step that did little to ease the pressure on the ruble, however, with the ruble temporarily falling to 118 against the US dollar on Monday morning before reversing slightly to the downside. Overall, the visibility on Russian local assets deteriorated significantly.
In addition to financial implications of Western sanctions, the economic consequences on the Russian economy cannot yet be fully quantified. Combined with the ruble’s weakness, sanctions are likely to push inflation higher, while tightening financial conditions will put further pressure on economic activity.
The high uncertaintycombined with the decrease in foreign investment and restrictions on access to technology and the global financial system are likely to dampen economic growth, which risks push the Russian economy into recession. The risk premium on Russian local assets has significantly increased as a result.
Given the bleak economic outlook, the ruble is likely to remain weak longer, in our opinion. We are therefore adjusting our USD / RUB 3 and 12 month forecast to 110. However, the uncertainty surrounding these forecasts is unusually high. Also, on Monday, Russia decided to impose capital controls, which effectively means that the ruble is no longer a floating currency. Political and geopolitical changes could therefore weigh heavily on the ruble in the future, making the long-term prospects very uncertain.
Global Equity Strategy
We increase the overweight Emerging Markets (GEM) area: China’s credit momentum has increased, which in turn leads to the relative outperformance of the GEM. We think that GEM currencies are in many cases cheap enough (with record real rate differentials and a base balance of payments surplus close to a 15-year high) to appreciate against the dollar (which we see stabilizing, holding the dollar has historically fallen after the Fed’s first rate hike).
GEM shares look abnormally cheap (DM relative P / B are back to 20-year lows), and relative earnings and GDP revisions are improving. Most importantly, GEM’s CFROI® is higher than DM for the first time since 2009. We focus on China and Mexico and update Brazil to overweight. Korea is the most cyclical market globally, but is discounting only 1% of global growth. India has the best structural history globally, in our view, but it does have some tactical headwinds.
Let’s reduce continental Europe to a small overweight: i) Europe is by far the most vulnerable region to Ukraine and to rising commodity prices (gas, oil and soft), which could reduce GDP growth to 2.5% from 4%; ii) increasing European wage growth to 3% and core inflation (including housing) to 2% means that the ECB is at its inflation target (and therefore ECB policy is likely to change little, at unless GDP growth slows to less than 1.5%): iii) Europe has dropped to number 3 on our scorecard.
We do not refer to it because: i) the European performance is suffering from a very large decline in SMEs (which Europe’s fiscal response makes unlikely); ii) the P / E are very cheap at a discount of 23% compared to the US; and iii) flows never reacted to performance. We also think that Europe is strategically much better positioned than in the past in terms of monetary and fiscal policy, the EU’s recovery fund forcing reform, the decline in popularity of Eurosceptic parties and the dominance of the region in green / renewable / sustainable companies. The unity and actions of the EU (especially German defense spending) on Ukraine have been remarkable. We remain overweight on Spain and Germany.
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