Policymakers Scrambling to Catch up with new realities

  |   Geopolitics, Macro

We live through truly transformative times with fundamental and major dislocations in politics, economics and capital markets. Independent and democratic Ukraine is under unprovoked military attack and suffering horrendous atrocities from totalitarian and revanchist Russia. This war, however, has global implications. Under attack are also multilateral institutions, humanistic values and free and democratic societies. The war in Ukraine is an era-defining wake-up call for democratic Europe, a brutal endpoint to post WW ll peace and a game changer in terms of taking economic prosperity for granted. 

Policymakers Scrambling to Catch up with new Realities

Sadly, many Western decision makers political leaders and central bank heads remain behind the curve in the hope to return to business as usual – status quo ex ante. But let us be clear on what political and economic history is teaching us: 

  • in geopolitics military aggression has to be met with superior military response, thus expect a prolonged and escalating military confrontation
  • ever higher inflation cannot be controlled without raising interest rates despite the typical risk of recession, thus expect tightening monetary policy and a weakening economic activity and capital markets

Russia’s Calculations and Miscalculations

In dealing with Russia, certain fundamentals must be understood and addressed:

  • Russia is firmly anchored in its 19th Century imperialist mindset based on identity and nationalism
  • Putin plans to celebrate victory over Ukraine with the 9th May 2022 military parade on Red Square, and watch whether China’s Xi Jinping will attend 
  • Russia’s military doctrine is to identify, target and destroy with the intent to break and erase Ukraine 
  • Stalin’s ruthless methods to crush domestic protests and power challenges are the role model
  • Putin cannot afford to lose this war and will keep doubling down the military aggression whatever the cost 
  • Sanctions will isolate and impoverish Russians, which sadly past generations are used to
  • Putin successfully fooled and corrupted the West for decades but colossally miscalculated this war and the Western response
  • Enormous human capital flight will exacerbate already poor demographics 

In Crisis lies the West’s Opportunity 

Country leaders of neighboring Eastern Europe are disappointed and critical of Western Europe’s insufficient political, economic and military response to stem the Russian military’s aggression and war crimes.

The West is more unified, strong and resilient politically and economically than ever but must rise to the challenge of stopping Russia and fully supporting Ukraine with maximum sanctions imposed and faster delivery of more and heavier weaponry. All eyes will stay on China and its support of the Russian regime, as the two share many historic grievances and aspirations. 

Putin, the self-appointed historian, better examines how most dictators have ended and revisits the 1918 Brest-Litowsk treaty rather than indulge in revanchist phantasies related to the 1945 conference in Yalta. 

De-globalisation, Inflation and Stagnation

The elephant in the room regarding further de-globalization centers on China and its authoritarian leadership’s readiness to cozy up with Russia. 

World economies are currently confronted with upward pressure on inflation rates and downward pressure on economic growth. Depending on further war developments and related sanctions this situation could significantly worsen. 

As a result, Central Banks who are still behind the curve face painful challenges and trade-offs. The problem started with supply-side disruptions and transportation-cost pressures triggered by the pandemic and now compounded by escalating energy and food prices – a wage-price spiral is thus a likely consequence. To get the genie back in the bottle without a recession appears rather unlikely. 

The flattening US yield curve is a clear leading indicator for weaker growth. The focus now is a likely sustained inversion combined with widening corporate high yield spreads and increasing default rates. As we know, contrary to leading consumer, business and investors’ sentiment data the labor market is a lagging indicator and inflationary pressures will not subside as long as unemployment rates remain low.

2022 Capital Markets Dislocations 

In December 2021 we wrote that in 2022, capital markets will be exposed to heightened risks of shake-outs, volatility and widening dispersion between winners and losers due to fractious geopolitics and shifting geo-economics. As key risks for 2022 we listed the ongoing pandemic, a wasted economic crisis and a potential Russian military attack on Ukraine.

In the face of current events we re-emphasize our defensive investment stance and believe that it is too early to increase exposure to risk assets. Worryingly, the falling bond yet continuously stable equity markets tell quite a different story. We prefer safe haven assets including cash, high-grade short-term Government bonds, CHF and gold as they deliver stability and optionality. 

Looking at equity markets the sectors to benefit are conventional and alternative energy as well as aerospace and defense sectors, profiting from the massive rehabilitation and upgrading of armed forces across Europe.

Article by Beat Wittmann, Chief Investment Strategist at Key Family Partners SA