Why haven’t global financial markets transpired since the Russian escalation?

Yet, as the world prepares for a possible war in Ukraine, we still know relatively little about the interplay between conflict and financial markets.

One thing we can say is that even during major armed conflicts, financial markets have often worked relatively well. A clear example is the Second World War.

Most people would probably think there would have been a big stock market crash in September 1939 with the invasion of Poland, or after the bombing of Pearl Harbor in December 1941. Yet, as you can see from the chart following the Dow Jones Industrial Average, that’s not what happened.

Rather, the market bottomed out much earlier, in 1938, when Hitler annexed Austria as part of his Anschluss plan to unite all of Europe’s German-speaking peoples. This was the first concrete signal of the build-up of a world war.

Until the fall of France in the spring of 1942, the markets remained extremely satisfied with the ongoing armed conflict. In fact, after hitting bottom again in 1942, the market began a bull run well before the end of the war.

This may have reflected the assumption that the Allies were beginning to pull themselves together. With the massive intervention of the United States towards the end of that year, winning the war began to appear as a concrete possibility.

The events of World War II show a key feature of financial markets: they only react sharply to unexpected events, while widely expected surges are priced in (already factored into valuations) well in advance.

So, for example, the 9/11 attack triggered a violent reaction in financial markets, but the widely anticipated military occupations of Afghanistan and Iraq were largely ignored.

This may be due to the very nature of financial markets. Investors hate uncertainty more than anything, and there are few situations more uncertain than the threat of war. When armed conflict erupts, however, to some extent uncertainty disappears and capital is reallocated.

Ukraine and the Markets These observations may help explain the complacency of international financial markets in response to Russia’s announcement that it is recognizing the eastern Ukrainian territories of Donestk and Luhansk as independent states and is sending “peacekeeping” forces to help defend them from Kyiv. .

The S&P 500, major European stock markets and the VIX (which measures market volatility) barely moved daily in response. In contrast, the Russian stock index fell by around 10%.

This could mean that international financial markets have already priced in the risks of a (minor) conflict with Russia in the context of falling stock prices over the past two months.

The view could be that, as severe as this escalation may be, it is unlikely to have a material impact on US, EU or UK economic fundamentals or corporate earnings. . If so, given Russia’s strategic importance as a net exporter of natural gas and oil, especially to the EU, this assumption could be questionable, to say the least.

Meanwhile, the fall in the Russian stock market may reflect the belief that Western sanctions will primarily affect the Russian economy. Of course, there is a possibility of contagion effects between countries, especially Russia’s neighbours, but these are difficult to quantify as they depend on other countries’ exposure to the Russian economy.

Either way, markets have been conditioned not to overreact to widely anticipated political and geopolitical shocks. However, keep in mind that Russian gas pipelines supply many parts of Europe. The price of natural gas in Europe has already risen 11% since Putin’s announcement, while Brent crude oil is up 1%.

If Russia were to turn off the gas tap or see its oil infrastructure damaged, we could easily see a bigger spike in the price of these resources, fueling already high inflation. Port disruptions around the Black and Baltic Seas could also exacerbate continued global supply chain disruptions, which could affect European and UK recovery from the pandemic in the short term.

In other words, while market complacency may have a reason, it should be taken with the proverbial grain of salt. And all this under the assumption that a possible escalation in Ukraine should be limited to the Donbass region. Unfortunately, that remains to be seen.

This story was published from a news feed with no text edits. Only the title has been changed.

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