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Few market bunkers if Russia invades Ukraine: Mike Dolan

Out of the frying pan and into the fire?

It’s hard to imagine a Russian military invasion of Ukraine being seen as anything other than a major geopolitical shock. And yet global investors have so far shown little inclination to park funds in traditional safe havens despite weeks of menacing troop buildups, reprisal threats and shuttle diplomacy.

Stocks have had a ropey opening to 2022 for sure and frontline investments in Ukrainian or Russian debt have suffered.

But there’s been no dash to liquid government bonds – quite the opposite in fact, as investors run scared of spiking inflation and central bank hawks. Neither had there been noticeable moves to Swiss francs, Japanese yen or even U.S. dollars – all part of a typical ‘safety’ playbook.

Precious metals and energy prices are the only ones to reflect the tension, at least partly, this year – even though separating the Ukraine influence from all the other factors is difficult there too.

Do markets no longer see such geopolitical flare-ups as economic shocks or market risks per se? Or is too difficult to adequately price investments around all political tail risks?

You hear people say both.

But a worry for some right now is that markets are trapped by highly correlated moves in stocks and bonds – following pandemic-related monetary rescue packages and now reversals.

What’s more, the most immediate economic impact from the standoff may simply be to spur already soaring energy prices, exaggerating pressure on central banks and national budgets and further deterring investors from what would otherwise be the default option of buying bonds.

“Everything is being seen through the prism of the Fed’s reaction function right now,” said Sahil Mahtani, strategist at asset manager Ninety One. Increasingly hawkish central banks focus on core rates of inflation, he added, but high energy prices have a big effect on embedding inflation expectations and policymakers will be concerned about that.

Mahtani said the apparent lack of safety plays around the Ukraine standoff mirrors the problem for mixed 60-40 equity-bond portfolios – there’s no real hedge if both asset classes are moving in the same direction.

While these mixed funds saw bonds and stocks buoyed together by the monetary stimuli to fight COVID, the unfolding ‘normalisation’ may have the blanket opposite effect. A typical global 60-40 fund gained about 40% from the March 2020 lows, according to Generali Investments, and this year could be very different.

Mahtani thinks dollar cash and very short dated Treasuries may still catch a bid if the worst comes to the worst in Ukraine.

But here too the picture is far from clear. The ‘long dollar’ bet on rising Fed interest rates is already seen as a crowded trade and the overwhelming consensus for higher dollar this year has been disappointed so far in January.


So are markets correct in remaining relatively circumspect about a full-scale invasion in eastern Europe?

Turning the heat up on Wednesday, U.S. President Joe Biden said his guess was Russia would now ‘move in’ as his Russian counterpart Vladimir Putin ‘has to do something’.

The White House pledged a ‘swift, severe and united’ response from U.S. allies. Economic and financial sanctions are detailed as first order, but some countries such as Britain have already sent arms to Kyiv and military tensions between Moscow and NATO would surely rise several notches.

The tension has been building for weeks – so there’s been ample time to position investments.

Maybe no one really believes it will happen and it’s all an elaborate bluff. But the seeming indifference is not in isolation and geopolitics – at least in the traditional ‘war and conflict’ sense – has been waning as a direct influence on world markets for years.

Russia’s annexation of Crimea in 2014 had very little immediate or durable impact on international prices – at least not compared to the collapse in oil later that year. North Korea’s growing ballistic missile threats have waned close to zero as a market impact in recent years too and the chaotic U.S. withdrawal from Afghanistan last year barely registered at all.

This month’s global fund manager survey by Bank of America didn’t even include the Russia-Ukraine standoff in its ‘Biggest Tail Risks’ category – with hawkish central banks, inflation, asset bubbles and a COVID resurgence topping the list and even US-China geopolitics in the Top 10 instead.

For all its nuclear arms capacity and energy market clout, Russia is just seen as far less economically systemic than China even in the event of a confrontation or draconian sanctions isolation.

However, the World Economic Forum’s annual Global Risks Report this week puts “Geoeconomic confrontation” – or the risk that geopolitical tensions spill into trade protection, energy price squeezes or cybersecurity threats – as 10th in its Top 10 most severe global risks over the next 10 years.

And maybe it’s here where markets price Russian sabre rattling more clearly than the threat of tanks and gunfire.

BlackRock’s strategists did include the risk of a Ukraine invasion as one of many risks to their latest advisory.

But they also stressed that market attention to geopolitical risks, as captured by its Geopolitical Risk Indicator, remains below the average of the past four years and has been since Biden took office.

“Geopolitical shocks could catch investors more off guard than usual.”

Off guard, and with few bunkers to hide in.
Source: Reuters (by Mike Dolan, Twitter: @reutersMikeD; Editing by Tomasz Janowski)

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