Russian invasion of Ukraine has greatly raised spectre of stagflation

The Russian invasion of Ukraine has added yet another major layer of market uncertainty that has greatly raised the probability of stagflation, a scenario which we have deemed an unlikely one for some time. Although our initial thinking after the invasion was that Putin’s probable end-game is to secure the separatists regions in Ukraine and build a land bridge to Crimea, we now fear that his goals seem far more ambitious in scope, to re-establish the old Soviet order that now threatens the eastern Nato states.

Moreover, given the policy momentum that is quickly building up by Western nations to increasingly isolate Russia, the occupancy of Ukraine now seems unlikely to end anytime soon. This in turn could ultimately leave Putin with no face-saving alternative but to cut off its supply of energy to Europe. Although the West have thus far avoided sanctioning Russian oil and gas in fear of sparking even higher energy costs, their decision to cease dealings with Russian banks, freezing their assets and the growing likelihood of kicking them out of Swift could indirectly lead us to the same outcome.

As we have seen in the case of China in the past few months, most market watchers have been hopeful that Russia’s recent actions which are simply bad for their economy and for business will prove short-lived and Putin will come to his senses. However, it is clear to us that both governments’ ideological drift from Western values now seems far more entrenched in their psyche and look unlikely to be reversed anytime soon for the sake of economic prosperity. 

All this draws a fairly bleak picture for global economies and for stock markets just when we were looking to emerge out of the pandemic. How big an impact the Ukrainian invasion will have on growth is anyone’s guess but clearly this will sour business sentiment across the world. One ray of hope is that with nuclear talks with Iran having seemingly made notable progress in Vienna before the end of February deadline, a potential agreement that will lift sanctions on Iranian oil could help stabilise energy prices, at least in the short-term and as long as Russian oil and gas continues to flaw westwards.