Why has Russia invaded Ukraine?

Russian President Vladimir Putin’s main motive for launching the invasion of Ukraine appears to be to prevent NATO’s expansion going further East into the Balkan states. That said, there is also another motive which is much closer to home for President Putin. Ukraine’s people and culture have drifted to the West and have become more European since independence from the former Soviet Union and Putin is also concerned about the impact of having a Western leaning democracy on Russia’s border. This is because economic success in Ukraine would highlight the corruption, underperformance and inequities of autocratic Russia. So, the invasion of Ukraine is also about protecting Putin’s reign from enemies within Russia and to strengthen his position in the upcoming Russian elections this year.

What has been the response of the rest of the world?

Ukraine is not a member of NATO, so Europe and the USA are not obligated to defend Ukraine militarily. To date it seems that the West is unwilling to engage Russia militarily, which is wise given Russia’s substantial nuclear arsenal. To date, the main response to the invasion by the West has been economic sanctions, which are targeted to hurt Russia’s economy and the Russian oligarchs.

How is the Ukraine war likely to play out?

While Ukraine has a strong military, it is not a match for the Russian army. That said, the Ukrainians are willing fighters and will provide strong resistance. While the actual invasion and defeat of Ukraine’s military is expected to come relatively quickly, much like the US occupation of Iraq, many military analysts believe that a full longstanding occupation of Ukraine (including taking Kiev) could prove to be very costly for Russia. Though Putin has said he does not intend to occupy the Ukraine.

The war with Ukraine does not seem to be that popular in Russia, Putin’s plan may therefore be to play the long game, seeking to only take part of the country (not including Kiev) and destabilise the Ukrainian government with the goal of putting in a Russian leaning leader in charge.

How does Russia’s invasion of Ukraine impact the markets?

Russia’s economy is only marginally bigger than Australia’s and less than 2% of the world economy. This is despite Russia having nearly six times as many people as Australia. So, the economic impact of the war is likely not material in terms of the global economy.

However, Russia’s economy has some similarities to Australia and is driven by commodity prices, with Oil and Gas being Russia’s main exports. From a market’s perspective, the key concern about the Ukraine war is Energy prices. Energy prices are a key driver of inflation, which is already very high in the USA and the West. Given that interest rates are already set to rise this year in developed economies to quell inflation, so the focus of markets is on how the Ukraine war will impact the decisions of central banks.

On this point, since the situation in Ukraine has escalated, the implied chance of a 0.50% interest rate hike by the US Fed in March has dropped from 60% to 11% today. (Essentially the markets are implying that a hike of only 0.25% is now all but guaranteed and the implication here is that central banks will not hike rates as aggressively as was expected prior to the invasion.)

How are we thinking about the impact of the war on portfolios?

While we obviously don’t know how the Ukraine war will play out, there are a few lessons from history we should head from previous geopolitical events:

Markets are unpredictable in the short run and market timing is difficult
Growth assets outperform over the very long run and being out of the share market on its best days can be extremely costly.

Markets tend to overreact to geopolitical events and then rebound over the next few months.

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