China looking under mounting pressure to force Russia into peace deal

As we have underlined in recent weeks, chances for stagflation have greatly increased as the impact of war in Europe is already showing signs of demand destruction on top of surging energy and other input costs that markets were already grappling with before the Russian invasion of Ukraine. So, although the outlook seems grim, we think there is a reasonably good chance that Putin will be forced to a ceasefire as his war money is running out fast and sanctions are looking devastating for Russia’s economy.

We also think that any prospects for peace will leave markets ignoring the current input cost factors and possible slowing of demand and could lead to a major rebound in stocks that will likely lift all boats. This is particularly the case as we are coming out of the pandemic and there is still huge amount of cash sitting on the side-lines. But, our focus remains top-down and on the fast-unfolding geopolitical events.  

With recent nuclear talks with Iran having hit “pause” as Russia has suddenly become an obstacle for reaching a deal, calling for sanction exemptions of trade between it and Iran, the return of Iranian oil now looks unlikely anytime soon. Obviously, this means that oil prices could remain elevated for a while, especially as OPEC says it has not much spare capacity for boosting output right now.

However, there a few other revealing and possible implications from Russia’s sudden U-turn to sabotage the deal, as Iranian themselves had compromised on a few major sticking points. It does suggest that Russia may have realised that this embargo on it could last a long time to come, even if war ends. Moreover, Iran’s return to the oil market makes cutting Russia off from energy markets less painful. 

More importantly, China’s trade with Russia is certain to come under closer scrutiny that could threaten sanctions on many Chinese firms (including its chip makers). We are closely watching this issue as we have long anticipated more severe export restrictions of tech to China and this conflict in Europe has left US policy makers very determined to punish China for breaking any key sanctions.  

As we also noted last week, we think China has much to gain from intervening here by brokering a ceasefire and trying improve its world status as a balancing super power that could enforce peace through its own sphere of influence. This comes at a time when it is regarded by the Western world with much distrust. 

Indeed, this distrust has been visibly deepening recently as China’s pledge of friendship to Russia, made just days before the invasion of Ukraine has left the West increasingly hawkish about China’s next move. However, one thing that we think looks certain now is that probabilities for China’s invasion of Taiwan, anytime over the rest of this decade has greatly diminished. 

In fact, Chinese government has become visibly uneasy about the televised loss of lives in Ukraine as Xi seems to have badly miscalculated the unfolding of events by trusting Putin to make his military operations relatively swift. China must be also shocked by the severity of Western sanctions on Russia and concerned that China could be eventually embroiled in future embargoes if it is seen helping Putin’s regime. 

So, there is little to gain in pursuing its more assertive foreign policy stance versus the West as Putin has totally changed that calculus. With the war looking likely to get increasingly uglier and China’s own economy under much duress from its Zero Covid strategy while its energy costs are going through the roof, the nation looks to be a big loser of Putin’s war, especially as weaker European demand will be hitting its exports. 

We think all these developments could be pressuring Xi to force Putin to negotiate a truce. This is especially so ahead of the China’s twentieth National Party Congress coming up in autumn where he needs to show the politburo that China remains in stable hands and not a global partner to some deranged autocrat.  But for China to intervene, it knows that there needs to be a face-saving way out of this war for Putin, at least as long he remains in power. 

With Ukraine now highly unlikely to be admitted into NATO in any event, pledging its permanent exclusion from the treaty and agreeing on making it a demilitarised zone are some of the options available to give Putin enough wriggle room to lure him to peace talks and to prevent more bloodshed. However, any official annexation of eastern parts of Ukraine including Crimea seems unlikely to ever be on the table. 

This is where China which is a big advocate of national sovereignty, could come in to weigh on Putin to compromise. If it can’t, then it is logical to assume that the Russian leader has no real end-game and is now totally unhinged. Either way, there seems little downside risk on betting on serious peace talks to emerge soon or indeed if Putin is somehow overthrown which is certainly looking likely in the medium term.