On Russia’s invasion of Ukraine

by Sean Tweedie | March 3, 2022

On the 24th of February 2022 Russia launched an invasion of Ukraine. At the time of writing this article, news of this event has penetrated every corner of the globe. News headlines are being dominated as this event unfolds. As with other previous major events, the flurry of media content can be overwhelming and difficult at times to keep up with. This event is no different. See Figure 1.

Figure 1
In light of this, I attempt to highlight the key considerations that are important for investors to understand when gauging the impact this may have on financial markets.

For Russia the most significant national security threat they face is a western military power based in Ukraine. Putin has been in power for 22 years and his national strategy is well-defined: he aims to resurrect Russian dominance within the former Soviet Union, carve out a regional sphere of influence, and reduce American military threats in Russia’s periphery. He has long aimed to prevent Ukraine from becoming a western defence partner by joining the North Atlantic Treaty Organization (NATO). Despite this Russia does not have the military capacity to attack the North Atlantic Treaty Organization (NATO) members, and because Ukraine is not a member of NATO it means that a broader war is not automatically triggered.

Much of the fear driving risk aversion in the markets now is the uncertainty about whether the fighting will spill over and expand into a broader war with NATO. Although not impossible, it remains unlikely because of the mutually assured destruction (MAD) from nuclear weapons. Both the US and Europe will not send troops into the Ukraine to fight, rather they will send troops and weapons to neighbouring countries to act as a deterrent to Russia to limit its operations.

In response to the invasion, the US and EU, amongst other nations, have levied a wide range of sanctions against Russia. It is unlikely however that these sanctions will dissuade Putin, and although these sanctions will hurt the Russian economy and financial system, they are unlikely for now to persuade the Kremlin to halt military operations in Ukraine. The Russian ruble plunged close to 30% on Monday following western sanctions over the weekend. Specifically, sanctions are removing some Russian commercial banks from the SWIFT electronic system and freezing the central bank of Russia’s (CBR) foreign exchange reserves deposited at foreign institutions.

Despite the sanctions against Russia, the EU will not halt Russian energy exports. In 2014 when Russia invaded Ukraine, Germany responded by working with Russia to build the Nord Stream II pipeline to import energy directly from Russia and circumvent Ukraine. Energy cooperation is extremely important, and any European boycott or Russian embargo would cause a recession in Europe, something European political leaders want to avoid at all costs. Nevertheless, the risk of energy cessations is an important risk for investors to monitor. If Russia is effectively barred from accessing their proceeds due to being cut off from SWIFT, then it would not make sense for them to export their gas. This would lead to near term disruptions in gas supplies and could lead to significant pressure on Europe. Figure 2 shows the reliance of Central and Eastern Europe on Russian gas exports.

Figure 2
It is likely that the situation gets worse before getting better which means we can expect more volatility in the financial markets in the coming weeks and/or months. Although sanctions will continue to hurt Russia, their actions and rhetoric will get more aggressive in the coming days and weeks. They are unlikely to halt operations due to the costs already incurred. Defensive currencies like the US dollar and the Japanese yen will strengthen whilst currencies linked to riskier assets will weaken due to risk aversion. Until there is a resolution to the conflict, uncertainty will continue to drive risk aversion in the markets leading to the selloff of risk assets.


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