Ukraine crisis a new risk to global growth

The most important event right now is clearly Russia's attack on Ukraine. It has been met by the harshest sanctions by the West ever seen on a country the size of Russia, see Research Russia - The West walks the talk with unprecedented sanctions against Russia, 27 February. Certain Russian financial institutions will be excluded from SWIFT and central bank assets have been frozen. Security analysts increasingly suggest that Putin's aim is to replace the Ukrainian government with a Russian puppet government which will secure that Ukraine will not become a NATO member, see FT. But uncertainty will prevail for some time on how the conflict will develop.

We see mainly three channels through which the crisis will weigh on growth - especially in Europe: First, the heightened uncertainty is set to weigh on business sentiment in the short term, but unless the crisis drags out for a long time, we believe the drag will be fairly limited and short-lived. Second, the rise in oil and gas prices will work to erode consumers' purchasing power and increase costs for companies. It also adds to the upward inflation pressure limiting central banks' ability to accommodate the shock. How big this effect is, will depend on Russia's retaliation on gas deliveries. Finally, growth will be hit from direct trade with Russia in a negative feedback from the sanctions. Trade with Russia has declined over the years, though, which should dampen the hit to exports.

While no doubt, the Ukraine crisis has added a downward risk to global growth, our baseline scenario is, that the impact will not derail the global expansion. Europe is most exposed whereas the effect on the US should be limited apart from the effect from higher oil prices. A pick-up in demand growth has also materialized in Asia over the past months and China is easing policy, which we expect to drive a moderate recovery during this year. 

Inflation continues to surprise to the upside and was in January 7.5% and 5.1% in the US and euro area, respectively. The crisis has triggered higher energy prices and exacerbated the inflation challenge with the risk of it becoming more persistent. For this reason, we do not see any big change to the outlook for Fed rate hikes this year. Undoubtedly, the probability of a 50bp hike in March has come down as the current uncertainty warrants a bit more caution and the Fed seemed split on a 50bp move even before the Ukraine crisis. However, we still expect the Fed will need to raise rates at every meeting this year as they are far behind the curve, see also Research US: How the coming Fed hiking cycle will differ - and why it matters, 18 February 2022. When it comes to the ECB, the stagflationary forces is causing challenges for ECB but barring a very negative growth impact, we continue to look for an end to asset purchases in September and rate hikes of 25bp in December 2022 and March 2023.

Equities have seen a strong sell-off on the back of the Russian attack with especially European stocks taking a hit. While we have been more defensive on stocks for a while we now see risks as symmetrical due to the repricing following the dip. We continue to look for bond yields to move higher over the coming quarters on the back of high inflation and Fed tightening not only via higher rates but also 'active quantitative tightening' by selling bonds starting in May. Geo-politics currently mitigate the upward pressure on global yields. EUR/USD has moved lower still to 1.12 and we expect the tightening cycle and economic slowdown to drive a further decline on a 12-month horizon to 1.08.

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