Highlights:

• Russia’s  invasion  of  Ukraine  adds  to the series of tectonic shifts from Covid, the   return  of   inflation   and  central banks’ search of a smooth exit.
• Limited  trade  and  financial  links  to Russia keep the direct risks to the EU and US recovery muted.
• Yet     energy    supply     is     the     key vulnerability. Sanctions have thus far eschewed Russia’s energy sector, but actions against the CBR and selected financial institutions may gravely hamper trade while sending Russia deeper into recession.
• We see no rush to buy the dips, waiting for more stability in the geopolitical and energy complexes. We further trim our prudent pro-risk bias, reducing both the Equity exposure in favour of Cash and the Cyclicals and Value bias.
• Exposure to energy offers hedging vs. the   risks  of   further   escalation  and hectic climate transition.

The massive Russian invasion is casting long shadows over the European security order. The ruble and Russian equities plummeted on news of the aggression. Risk premia and energy prices soared on fears of new supply disruption threatening both the energy complex and the global recovery.

Indeed, the surprise effect has been significant: President Putin escalated the crisis despite severe economic and potentially military  costs.  While  he declared the demilitarisation of Ukraine a key goal, his true plans remain opaque. Hopes that he may only try to achieve a better negotiation position to stop NATO’s expansion have been dashed. It is not clear either that the demilitarisation simply aims at securing the full separatist control of the Donbas provinces. Putin will likely try to  impose a pro-Russian government in Ukraine, and may even annex the country; given the size of Ukraine and its army, this may mean prolonged fights and human victims. In a worst-case scenario, Russia would deliver a full-blown invasion that may reflect ambitions to redraw European borders.

Far reaching sanction still eschew energy

Western allies will not send their armies to Ukraine but are already offering military support (e.g. selling arms). They have also announced far-reaching sanctions, curtailing Russia’s financial sector, sovereign and corporate financing, technology exports and key individuals. Sanctions on the CBR – a first ever for a G20 central bank – will restrict it in from deploying its FX reserves and mitigating the broader sanctions. The CBR then had little choice and delivered a massive rate hike and capital controls that will only add to the economic misery. EU leaders have already agreed sanctions targeting 70% of the Russian banking market (including selected bans from SWIFT payments) and important state-owned companies. Also the trading of Russian sovereign debt will be severely curtailed.

What direct economic impact on Europe? While the crisis will surely cause a recession in Russia (as well as double-digit inflation), deeper ties with China, a lower dependency on USD funding and the development of its own payment system may reduce the blow.

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