Eugene Kiernan: Ukraine war will further exacerbate economic uncertainty
Concerns over inflation, supply chains and GDP-to-debt ratios will increase as the Russian invasion continues
The war in Ukraine, while above all a deeply sad humanitarian crisis, may impact practically every aspect of our future lives.
Following on the heels of a pandemic that continues to take its toll, the war will cast a long shadow.
Financial markets are one barometer of the impact beyond Ukraine’s borders. But historically, markets have found it very hard to price geo-political risk. Moves may appear indiscriminate, but they are widespread and substantial with significant impact on general savings, pension funds, sovereign wealth funds and others.
Initial calls from investment houses were very much to hold positions. Some advised to reduce risk slightly while still being “risk-on”. Several large investors looked to what stock markets had done in recent outbreaks of conflict such as the Gulf Wars, Iraq, Vietnam. In these instances markets regained their poise in relatively short order. But in certain respects many of these events were quite contained.
There is little about this Ukraine war that is contained. One of the aspects of the current crisis is that it has seismic impacts on a wide range of issues. And these issues were already “in motion” in financial markets and were top of mind for many investors.
For example inflation. Inflation has been a hot topic in markets for the past year as Central Banks gave up on their view of price increases being only transitory. Annual price increases of over 7 per cent have become a hot political issue in the US. However, now, the risks around cuts to oil supply or possible embargoes have pushed gas prices at the pump in the US to well over 4$ a gallon – double what they were 20 months ago. Even sourcing oil elsewhere will bring higher transportation or refining costs. Moodys estimate that a lengthy military conflict leaves oil prices extended in to 2025. Grain prices will see a similar profile.
Covid raised the profile of supply chain disruption and the war brings further pressure especially in industries like autos, which had already been facing shortages in semi- conductors. However the added pressure especially for German car makers comes from the lack of wiring harnesses, which are typically manufactured in Ukraine for shipment to European facilities. Even transfer to other plants would increase the costs as harnesses are a more labour intensive product. Supply chain disruption remains a theme for markets.
Another trend that gets amplified is the slowdown in global economic growth. Well before the war, institutions such as The World Bank, OECD and the IMF had already moved to factor in a gentle slowdown in the rate of global economic growth this year and next. The war, because of issues such as the impact on investment, consumer nervousness, supply chain disruption, impaired logistics etc, accentuates that fall. And the impact is not evenly distributed — with Europe in the vanguard. As an example, the impact of a sustained 20$ hike in the oil price would knock 0.3 per cent off US 2022 growth, but about 1.2 per cent off activity in the Euro area. And if conditions escalated in the Ukraine or moved elsewhere, the prospect of a global recession cannot be ruled out.
And all of this is happening at a time when many governments were hoping to restore discipline to public finances post the spending surge in the battle against Covid. Eurozone countries debt to GDP ratios rose from 85 per cent pre-Covid to 100 per cent. The hope was that 2022 would be the year to reassess this emergency level spending. EU officials may now hold off reactivating the Stability and Growth Pact in 2023 given the current level of uncertainty. The mood to increase spending was exemplified by Germany’s decision to set aside €100 billion for defence spending. Increased spending commitment to Nato are also likely over the next few years. Moves elsewhere such as Ireland’s reduction in excise taxes on energy also move public finances in the same direction.
We are seeing market moves of 3-4 per cent on a daily basis. Lack of visibility on a solution, coupled with the seismic impact events in Ukraine are having, on what were already “red button” issues for markets, suggest the volatility will persist.
Eugene Kiernan is an independent investment strategist and is president of the Chartered Institute for Securities and Investment