Arguably, Europe must be the biggest potential loser of conflict in Ukraine. Having barely survived the so-called euro crisis, a new "Cold War" looks like pretty much the last thing the Old Continent now needs. Nevertheless, subtle medium-term market signals are warning us not to give up on Europe just yet - indeed, they suggest that the recent European stock market sell-off was just the final shakeout amidst an ongoing turn-around in favor of the euro area.
During the market correction in June and July, financial markets were once again a fertile ground for visions of gloom & doom. The most plausible of which could be summarized as follows: Recent events have increased the risk of Europe sliding back into recession, while other regions appear to be in a more benign position. In particular, resource-poor countries, especially those with very flexible central banks, could even benefit from Europe’s latest predicament - whose net global impact should be deflationary.
The Ukraine crisis comes at an inopportune time for Europe as a whole. Eastern Europe is stuck in a geostrategic dilemma and a timid economic rebound in Southern Europe looks vulnerable. Even in Europe’s highly developed industrialized North, some countries continue to face deflationary headwinds, owing to burst property bubbles and other local issues that played out in recent years (e.g. Denmark, Netherlands and Sweden).
A total loss of access to Russia’s market would also hurt businesses in Germany and other relatively strong economies. Finding alternative export market takes some time, and can sometimes trigger cut-throat price competition - which would add to the preexisting deflationary forces. As economic sanctions escalate, investments in Russia would have to be written down at some stage - a prospect that could again undermine the European banking system, whose problems can still trigger global scares, as a recent Portuguese bank bailout showed.
Meanwhile, the rest of the world seems to be in a rather good shape by comparison. The United States has been pivoting more towards Asia in recent years, and is a much less export-reliant economy in the first place. For North America, the risks are thus rather modest. Many emerging economies are also among the potential winners of the crisis, as well as the world’s second and third largest economies - i.e. China and Japan.
If the sanctions cycle continues to escalate, Russia will seek and find alternatives to the EU energy market. But Moscow’s price-negotiating position could be comparatively weak, as it might have an interest in offering attractive terms to these new buyers, perhaps for political reasons - and the overall net impact would again be deflationary. We have already seen some hints in this regard. For example, a recent energy agreement between Moscow and Beijing is reported to have been reached amid favorable conditions for China, while Japan was excluded from some of the recent Russian counter-sanctions against the Western countries, even though it supports the US and EU positions on Russia.
As things stand today, most experts do not expect a quick East-West détente regarding Ukraine. The markets, meantime, seem to envision falling energy prices - and thus increased scope for central banks to maintain or even expand monetary accommodation. Furthermore, such an outcome would benefit domestic demand-driven economies, like the US, as well as resource-poor nations such as China and Japan (especially if their economies are highly leveraged or in the process of leveraging up).
Of course, such thoughts are largely speculative for now. Still, it makes sense to view Europe, including Russia, as the biggest potential loser of the Ukraine crisis, and accept that other countries and regions might actually benefit from the situation - not least because… well, when two people quarrel, a third rejoices. And yet, at the same time, the underlying medium-term trends in the markets are warning us not to throw in the towel with regards to Europe just yet - these subtle price signals indicate that the whole affair could in fact soon prove to have been nothing more than just another market quirk. In that case, Eurozone equities should start outperforming again before too long - as they have been doing since May 2012.
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