LONDON, Nov 11 (Reuters) – Dissolving the biggest shock to the world economy this year could prompt a rebound in global markets that many investors see as long overdue – but could also spark other troubling situations. the problem.
Whispers about the final phase of Russia’s nine-month invasion of Ukraine — from “talking about negotiations” to any suggestion of a negotiated ceasefire — have been circulating in the media over the past week. Global investors pay as much attention to all of this as politicians or military strategists.
With another major Russian retreat from the battlefield, there has been concern over direct talks between Washington and Moscow, Kyiv’s staunch denial of negotiating pressure and some fears that a post-election stalemate in the U.S. Congress could hinder the emergence of a new Ukrainian military aide.
And that’s all ahead of next week’s G20 summit in Indonesia – at least as Washington and Beijing seek to defuse recent tensions between the two biggest economic powers.
To be sure, the slaughter, destruction and suffering in Ukraine since the invasion of Ukraine on February 24 has exceeded its scale—Russian military casualties and economic isolation have paid a high price for the stalemate, and now the territorial gains are diminishing.
But the global economic impact after February is arguably larger than any conflict before the end of the Cold War 32 years ago — and far outweighs increased military and defense spending in Europe and the United States.
Western sanctions against Moscow have fueled an explosion in energy and food prices, exacerbating and prolonging a post-pandemic inflation surge across the globe. That has forced the government to ramp up spending to ease costs for households and businesses, and major central banks to raise interest rates sharply.
The combination of cost-of-living crises and recession warnings combined with a global liquidity drain has exacerbated geopolitical risks everywhere. The result was the worst year in a century for a mix of stocks and bonds.
Even the faintest light in that darkness may now seem like a beacon of hope.
Despite bottoming out a month ago, global stock indexes are still around 16% below their record levels in the first week of February, when U.S. intelligence first warned of a full-scale Russian invasion. Since then, global government bond prices have fallen about 20%, while the dollar has gained 14%.
To be sure, few believe that any end to the conflict will revert to the status quo on a political or economic level — especially since broader inflation and economic trends have come into play. Even if the “hot war” ends, Ukraine’s bills, Russia’s isolation, energy outages and military tensions could linger for years.
But some moderation could still have an exaggerated impact on the global investment landscape, as long as it improves visibility into next year, reduces some of the worst military “tail risks” and allows for the normalization of the most bearish portfolio positions in more than a decade. Any shift in the level of central bank interest rates will amplify this.
Central bank “out”
Jim Leaviss, M&G’s chief information officer for public fixed income, pointed to Thursday’s sharp surge in markets following news of an unexpectedly sharp drop in U.S. inflation last month, a sign that investors are willing to start looking “in the right direction” from here.
“The market is clearly eager to see any indication that the central bank may turn,” he said, adding that the CPI data alone would reduce the Fed’s interest rate level by at least 25 percentage points next year.
Any suggestion of ending the conflict in Ukraine would immediately fuel hopes for a sharp cut in energy and food prices next year and see markets react in a similar fashion.
“This would remove a lot of rate hikes from all central bank assumptions,” Leaviss said. “Basically, this puts the central bank ‘out’.”
Oil, natural gas, wheat and some metals are likely to fall first — improving inflation expectations.
For bond markets, the positives that dampen inflation and the outlook for policy rates have multiplied with improvements in government and corporate coffers — allaying fears of more public borrowing or a spike in high-yield defaults.
Stocks will rekindle hopes for next year’s fabled “soft landing” — eased borrowing rates that would improve financing, consumer demand and some stock valuations.
Given Europe’s proximity to conflict zones and its huge natural gas exposure, stocks in the region should outperform. Terms of trade against the euro and other currencies around the world could ease, while any “safe-haven buying” in the greenback could cause the greenback to give up at least some of its extreme gains in 2022.
The geopolitical risk premium that increased hard-hit Chinese investment – partly due to heightened sanctions risks after Ukraine – may also ease.
But there are some caveats.
Some investors believe that energy cuts and a boost in economic sentiment will only keep inflation in the system longer – especially if central banks therefore choose to ease the monetary brakes
Amundi’s head of multi-asset investment solutions, John O’Toole, believes that Ukraine’s rebuilding will immediately spark speculation – funding projects and stock market boosts for European industrial and materials companies through international conferences.
But he doubts the overall picture will be seriously deflationary – and thinks net stimulus may be more dominant.
“If there is no recession next year, inflation will remain sticky and interest rates will remain high.”
The views expressed here are those of the author, who is a columnist for Reuters.
Author: Mike Dolan, Twitter: @reutersMikeD Editor: Lincoln Feast
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The views expressed are those of the author. They do not reflect the views of Reuters News, which is committed to integrity, independence and impartiality in accordance with the principles of trust.