What are tensions around Ukraine telling us?

Anthony Rayner

Premier Miton Macro Thematic Multi-Asset Team

Zooming in on Ukraine itself is fairly unhelpful. Now, as in the past, Ukraine is caught in the middle, economically, culturally and politically. It lurches from one crisis to the next, as it is pushed and pulled by greater powers.

The greater powers, in this case, are the US and Russia. What do they want? From a geopolitical perspective, Russia principally wants to turn attention to NATO expansion towards its borders. The US, meanwhile, is concerned that Europe, and particularly Germany, is becoming more aligned to Russia.

Over recent years, we have seen an emboldened Russia. A Russia that is strategically, i.e. politically and economically, moving closer to China. For example, both Russia and China have denounced further enlargement of NATO. Domestically, Russia is in a much better financial position, with healthy current and fiscal accounts, as well as ample foreign currency reserves. As a result, they would be more resistant to further sanctions. At the same time, for Russians looking overseas, the image of the US is a weaker one, post Afghanistan, and with a very divided Congress, and society. In short, Russia wants more respect, and to still be seen as a superpower.

Germany, meanwhile, has been somewhat passive so far but for good reason, and not just due to the second world war. The new German coalition is acutely aware that a large amount of their gas comes from Russia, with a recent focus on Nord Stream 2 (the Baltic Sea pipeline), which would bring gas directly to Germany, bypassing Ukraine. Going forward, Germany’s reliance on foreign energy will likely increase, as nuclear energy and coal are phased out. As a result, the sensitivity of Germans to sanctions on Russia will be somewhat higher than the US and UK.

So far there has been some flexing of muscle and, let’s not forget, the US and Russia are the world’s two largest nuclear powers by some margin. However, we still continue to believe that the most likely outcome will be a face-saving exit, with some of Russia’s key demands met. That said, with tensions high and trust low, there remains a real risk of an escalation, accidental or otherwise. More generally, while the focus is currently on Ukraine, with US power waning and new alliances building, we should expect more frequent flare ups globally.

From a financial market perspective, there has been an impact across assets. Specifically, oil and natural gas, as well as wheat, the Russian ruble and safe havens such as gold, government bonds, the Japanese yen and the Swiss franc.

We would rarely look to position for material geopolitical risk, as it’s so opaque. That said, we do have some general geopolitical hedges in the portfolio, principally gold and, depending on the source of the risk, some oil exposure, as well as, of course, some government bonds, though with reduced duration.

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