A brutal come-down expected for Europe
The war in Ukraine will have lasting effects on the global economy – how extensive those effects will be is currently unknown. While markets have returned to their pre-crisis levels, the shadow of stagflation weighs heavily on Europe.
By Bertrand Beauté
The war has turned the markets both hot and cold. "Since the start of the conflict, markets have forgotten the fundamentals a bit," says Mabrouk Chetouane, head of Global Market Strategy at Natixis Investment Managers. "They react to current events, following good and bad news, rather than tangible economic outlooks."
On 8 March, when peace talks were announced between Russia and Ukraine, the STOXX Europe 600 increased nearly 5% in one day. A few days earlier on 3 March, that same index, which is made up of the 600 largest European capitalisations, was down by 3.5%. Why? After a conversation with Russian president Vladimir Putin, French president Emmanuel Macron said the following: "The worst is yet to come," feeding the flame of chaos that has been disrupting the markets since the start of the invasion on 24 February.
"We’re going to see even higher levels of inflation"
Alan Mudie, chief investment officer at Woodman Asset Management
As a sign of this anxiety, the European volatility index VSTOXX – dubbed the fear index – reached nearly 60 points on 7 March, by far its highest level since March 2020, and then fell below 30 points by late March – its pre-crisis level. "Uncertainty about the war led to a certain nervousness from investors at the start of the conflict. But the situation is beginning to normalise," said Chetouane. “Markets adjust to everything. They adjusted to Brexit, to the China-US trade war, to COVID, to the annexation of Crimea... They will adjust to this crisis as well."
Indeed, as of the end of March, most European indices had already recovered their losses since 24 February – the day Russia invaded Ukraine. "Investors, who initially feared a breakdown in the Russian gas supply, escalating conflict in Europe, or even the outbreak of a Third World War, were somewhat reassured," says Hubert Lemoine, chief investment officer at Schelcher Prince Gestion. "They accepted the idea of a long conflict that remains limited to Ukraine, with a diplomatic agreement in the more or less long term."
But this market optimism seems to be at odds with the economic reality, particularly in Europe, which is on the front lines of this conflict due to its dependence on Russia for energy. "Before the war, inflation was already a threat. The invasion of Ukraine made the situation worse," said Chetouane. "According to our projections, inflation is expected to reach 5% in 2022 in the Eurozone and 2.9% in 2023. These are unprecedented levels." According to Eurostat, the annual inflation rate in the Eurozone was 7.5% in March, after a 5.9% increase in February. This is the highest level since the indicator was first produced in 1997.
This is due to the fact that the price of raw materials, energy and foodstuffs has increased since the start of the conflict. "We’re going to see even higher levels of inflation," warned Alan Mudie, Chief Investment Officer at Woodman Asset Management. "We need to keep in mind that this geopolitical crisis is here to stay. Europe wants to massively reduce its imports of Russian energy, but that will take time: 40% of natural gas consumed in the European Union comes from Russia, so a quick pivot is not possible! Energy prices could be high for a long time."