Russia/Ukraine: markets have not priced in worst-case scenarios

God created war so that Americans might learn some geography, quipped Mark Twain. Geographically challenged Europeans also have good reason to look up Ukraine on the map. Russia has warned the US and Nato to make concessions or face a worsening security situation in Europe.

Markets are so far unfazed by the threat of war. If there is a conflict — perhaps a partial Russian invasion of Ukraine — the focus would be on energy. But prices would be affected far more widely via inflationary pressure.

Natural gas prices in Europe already reflect a squeeze on local inventories. A quintupling of natural gas prices on the continent and in the UK has pushed up electricity prices too. Energy has surged out of its usual trading ranges. It would go higher still if Russia invaded Ukraine and stopped exporting gas.

Energy price rises would put pressure on retail suppliers, such as Centrica, and big consumers, for example chemical makers. It would benefit explorers such as UK-listed Serica Energy, whose shares have already more than doubled over one year. Europe might even have to fall back on coal, says Bjarne Schieldrop at SEB in Oslo.

The US is unlikely to intervene militarily if Russia invades its smaller neighbour. Instead, America would tighten sanctions, Cutting off the US banking lines of Russia would wreak collateral damage on US banks and corporations they deal with. Russia’s economy is shambolic but it has considerable wealth, reflected in $630bn of foreign exchange and gold reserves, the highest since at least 2007.

Ukraine’s sovereign bonds have performed poorly. Its US dollar 7.4 per cent coupon 10-year bond has dropped since October. The yield spread to its US Treasury equivalent has widened 200 basis points since mid-October.

Companies operating in Ukraine such as Ferrexpo are also at risk. The market worth of the London-listed iron ore miner’s shares has fallen in line with the commodity, leaving it valued at £1.8bn. An invasion would drive shares down further.

At present, there is more jaw-jaw than war-war. Expect big price moves if peace talks fail and tanks start rolling.

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