Scenario 02 — A negotiated deal between Russia and Ukraine
This is the scenario, which is obviously the closest to our heart on all counts. It first involves a ceasefire and then an agreement from all parties to find a solution to the conflict. Such a rosy scenario looks unlikely at this stage given the high level of tension but a visit to Moscow over the last week-end by Prime Minister Naftali Bennett of Israel to meet at the Kremlin with President Putin shows that a negotiated deal is still an option (medium to high probability from our point of view).
Should a ceasefire take place, some of the sanctions will be progressively lifted but not all of them.
Macro impact
A negotiated deal means that our 2022 global outlook assumptions – i.e global growth above trend – are still valid.
We also expect inflation to peak in the first quarter and then start to normalize although it is likely to stay above central banks’ target for some time. Central banks will seize this window of opportunity to tighten monetary conditions according to initial plans.
Market impact
Such a scenario will be slightly bullish for global equities. Earnings are expected to grow in the high single digits. Valuation ratios will initially expand due to the relief of geopolitical risk but multiples will be capped as bond yields are expected to resume their upward trend. International stocks (Europe, Japan) are likely to catch up some of their recent underperformance while value should outperform growth.
Within Fixed Income, credit and emerging markets spreads are expected to tighten. Government bonds yields are expected to resume their upward trajectory (bear flattening).
With a ceasefire, we expect commodities outperformance vs. equities to come to a halt as Energy and Food prices are likely to come back to pre-crisis levels. On the currency side, the Euro should strengthen against the dollar and the Swiss Franc.
Scenario 03 — A Russia-NATO armed conflict including the use of tactical nuclear weapons
This is basically the ugliest scenario both from a human and macroeconomic perspective. The odds are medium to low but it is indeed a very fat tail event with meaningful consequences for our daily lives and obviously for financial markets.
This scenario could occur if the conflict spill over to the West with NATO becoming involved. A deepening crisis would most likely result in massive energy supply cuts to Europe and a trade blockade at the global level.
Macro impact
The resulting macroeconomic effect would be a full blow global recession. While commodities prices and inflation would initially soar, the recession will lead to demand destruction and thus lower commodities prices and deflation in the medium-term. The high level of leverage in the system creates a high risk of sovereign debt crisis and corporate defaults.
