The war in Ukraine at a turning point
By calling the war in Ukraine a «tectonic shift in European history», European leaders are giving an indication of the regime changes this war could lead to in the medium term.
In the short term, the economic consequences of the war will depend on how long and how intense the conflict is. A few elements allow us to make an initial assessment after one month of war:
- Russian forces are bogged down on the ground, experiencing serious logistical problems (lack of fuel, rations and perhaps even ammunition) and are suffering initial military setbacks.
- The resistance and fighting spirit of the Ukrainians, supplied with weapons by at least 28 countries, is proving effective. The fight is more intense and longer than Russian military strategists had anticipated. The human and material cost for the Russians is considerable. Ukrainian officials estimate that some 17,000 Russian soldiers have been killed, which is more than during the war in Afghanistan (15,000 dead in 10 years).
- President Zelensky has established himself as a warlord both within his country and globally. His high-profile appearances before the parliaments of Western democracies have made him a heroic figure who embodies and galvanises the resistance.
- On the diplomatic front, talks resumed in Turkey between the Ukrainians and Russians after a three-week break. Russians announced a change of strategy and promised deescalation but there has been no significant breakthrough. The focus is on the conditions for a ceasefire. The status of the occupied territories (Donbass and Crimea) is not on the agenda, but it is clear that this will be at the heart of the upcoming negotiations. President Zelensky would accept Ukraine’s neutrality subject to guarantees for his country’s security (with a guarantee close to that of NATO’s Article 5) and approval by referendum.
- The EU has decided to gradually reduce its energy dependence on Russia with the support of the G7 countries. The hydrocarbon sector is still relatively untouched by the Europeans, but pressure has been stepped up; Germany is already aiming to: (i) halve its Russian oil imports by the summer, (ii) stop importing Russian coal by the autumn; and (iii) stop importing Russian natural gas by mid-2024.
In short, Vladimir Putin is already facing deep economic and political challenges. And on the military front, the setbacks are mounting. From our point of view, the events of March increase the probability of a “short” war with a cease-fire and full-fledged negotiations in the coming months. China’s bargaining power has de facto increased considerably and we continue to believe China will play a key role in ending the crisis. In the short term, the risk of a “vertical escalation” - with the use of unconventional weapons: chemical, biological or even tactical nuclear weapons - has been reduced. However, the negotiations will take a long time and it seems to us that it would be a mistake to consider that the risks of an escalation or even a widening of the conflict have disappeared. Uncertainty is elevated and it remains necessary to consider alternative scenarios.
In any case, this war will mark a turning point in international relations and military doctrine in Europe, and lead to a new form of globalisation. This conflict challenges doctrines that have been well established for decades, in particular the paradigm that economic integration is a bulwark against war. This crisis exacerbates the need to diversify supply chains and to relocate some production for strategic and/or resilience purposes. Economic links with Russia are definitely weakened.
Finally, from an economic point of view, the war in Ukraine aggravates the dilemma of the main central banks because, on the one hand, it will push inflation even higher (with spillover effects into all prices), and on the other hand, it increases the risks of a slowdown in growth. This dilemma is all the more pronounced as central banks underestimated the inflationary consequences of the fiscal and monetary measures taken during the Covid crisis. This is particularly true in the US. One lesson from the late 1970s and early 1980s is that late action can lead to inflation taking root, requiring more aggressive tightening and causing longer-term pain. But the other lesson is that soft landings are difficult to achieve, and that the risks of recession increase when financial conditions tighten too quickly.
It is between these two pitfalls that central banks – and investors – will have to navigate. In this document, we seek to provide some guidance to investors in this very uncertain and shifting world.