The President of the Russian Federation, Vladimir Putin, signed executive orders to recognize two republics in the Donbas region of Ukraine, Donetsk and Luhansk. This official recognition has provided the pre-text for Russia to order troops into that region of Ukraine. The increased geopolitical risk is weighing on global markets. U.S. markets were closed for the President’s Day holiday, but markets in Europe and Asia were down around 2% yesterday. The damage in sentiment was more visible in the Russian markets where stocks lost over 10% and the Russian currency declined more than 3%.
Technically, The Donbas region has been Russian-controlled since 2014
Since the Russian invasion of Crimea in 2014, the Russian-speaking Donbas region of Ukraine has been controlled via heavy Russian influence and military stationing. Now, with Russia’s official recognition of the breakaway republics, an agreement signed between the parties which claimed to be based on friendship, cooperation, and mutual aid, allows Russian troops to officially be based in these two regions.
A full-scale invasion of Ukraine cannot be ruled out but our take is the probability of such an outcome has lessened
As mentioned in previous publications, Russia appears not to be intent on a full-scale invasion of Ukraine. The current situation is akin to Russia's invasion of breakaway republics in Georgia in 2008 and Crimea in 2014. And while Russia has amassed over a hundred thousand troops around Ukraine, military experts note that the current build-up is not enough to take and keep control of all of Ukraine. The current standing is a good enough win for local politics in Russia, and de-escalation could begin from this tipping point.
Types of sanctions will show the West’s hand
The U.S. and its allies in Europe are working on a list of sanctions to be announced shortly. Sanctions could limit investments in these newly recognized republics and on certain people operating there as well as parts of greater Russia.
The global economic fallout could be contained if subsequent sanctions on traded goods and services from Russia stay limited. Russia is a major exporter of energy and industrial metals like platinum, palladium, titanium, nickel, and aluminum, as well as grains. However, any sanctions on these commodities and products would likely lead to upward inflationary pressure in markets, where inflation is already at multi-decade highs.
Higher energy and agriculture prices could disproportionately hit vulnerable members of emerging and European economies relying on commodities and energy sourced from Russia. The U.S., with its energy mostly sourced locally, is less vulnerable to supply shocks than in the past. This is one of the reasons we remain overweight domestic equities relative to international markets.
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