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What the Russia-Ukraine Conflict Means for the Global Economy and Markets

Goldman SachsDaan Struyven, Peter Oppenheimer, Kamakshya Trivedi, Alison Nathan
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Economic Impact Channels

  • The Russia-Ukraine conflict affects the global economy through four primary channels:
    • Direct GDP loss in the region, though limited globally due to the combined 2% market-weight and 3.5% GDP-weight share of Russia and Ukraine.
    • Reduced exports to the region, constrained by the 2% share of global trade with these nations.
    • Contraction in commodity supply, with Russia producing 17% of global oil and 11% of global gas, alongside major shares of wheat, fertilizers, and corn.
    • Tighter global financial conditions driven by market volatility.

Financial Conditions and Growth Forecasts

  • Global Financial Conditions Index (FCI) has tightened by approximately 50 basis points, with a 25 basis point tightening observed excluding Russia.
    • Sustained tightening of this magnitude could reduce global growth by 0.2 to 0.3 percentage points.
  • Goldman Sachs Research anticipates that if the 25 basis point tightening persists, it will subtract from global growth, though current levels are fluid and subject to rapid change.

Inflation and Commodity Forecasts

  • Euro area year-end headline inflation forecast has been revised up by nearly 0.5 percentage points to 5.4% due to energy costs.
    • Europe is particularly vulnerable, importing 20% of its gas from Russia, with Germany's dependency reaching 60%.
    • European gas price forecasts were revised upward by 120% following the halt of the Nord Stream 2 approval.
  • Global headline inflation is projected to rise by approximately 30 basis points primarily due to oil market disruptions.
    • Brent oil is up ~25% year-to-date, trading above $100 per barrel.
    • Emerging markets face amplified inflation risks due to higher exposure to fuel costs in their consumption baskets.
    • Food prices are also rising, driven by supply disruptions in wheat and fertilizers from the region.

Monetary Policy Implications

  • Central banks face a "bimodal" trade-off between upside inflation risks and downside growth risks, particularly in Europe.
  • Federal Reserve Outlook:
    • Maintained baseline forecast of seven 25 basis point rate hikes in 2022.
    • Added a fourth rate hike to the 2023 forecast, raising the total to 11 hikes, driven by upgraded inflation projections.
    • Shifted preference away from a potential 50 basis point hike at the March meeting in favor of 25 basis point increments to avoid unpredictably tightening financial conditions.
  • ECB Outlook:
    • Baseline forecast remains two 25 basis point rate hikes in 2022 with liftoff expected in September.
    • Adjusted strategy to abandon commitment to ending QE in March, opting instead for data-dependent decision-making due to geopolitical uncertainty.
    • Markets are currently pricing in a dovish outcome, though the bank's baseline remains hawkish.

Fiscal Policy Shifts in Europe

  • Germany announced an increase in defense spending by 0.7% of GDP for the current year, which could boost growth by 0.5 percentage points immediately.
    • This signals a broader trend as other Eurozone nations (e.g., Spain, Italy) currently fail to meet the 2% NATO defense spending pledge.
  • Fiscal support is expected for Ukrainian refugees, with estimates suggesting up to 7 million individuals requiring hosting and aid in Europe.
  • Accelerated investment in energy security, including LNG terminal construction and net-zero transitions, is projected to increase budget deficits.
  • The crisis may catalyze deeper fiscal integration in Europe, potentially leading to a "Recovery Fund 2.0" to assist economies most exposed to energy shocks.

Equity Market Analysis

  • European equity markets have entered correction territory, driven more by inflation and growth concerns than by the initial shock of the invasion itself.
  • Equity risk premiums have surged to levels significantly higher than most recent geopolitical events, reflecting extended uncertainty.
  • Tactical opportunities exist due to depressed risk appetite indicators, suggesting markets may have priced in much of the bad news.
  • Bull and Bear market indicators suggest vulnerability but not an imminent deep, lasting bear market.

FX and Emerging Market Dynamics

  • The Russian ruble depreciated 40-50% year-to-date, with central bank rates raised from ~9% to 20% to defend the currency.
  • A significant portion of Russian central bank reserves (those held in G7 currencies) has been frozen, removing the ability to intervene in local asset markets.
  • Emerging market spillovers are most acute in Central and Eastern Europe (e.g., Poland, Hungary, Czech Republic) regarding currency and equity pressure.
  • Commodity price spikes are increasing inflation risks for emerging markets, forcing rate hikes in several jurisdictions.
  • Positive spillovers exist for distant commodity exporters, with asset performance in countries like Colombia and Middle Eastern sovereigns correlating positively with oil prices.
  • The US dollar has strengthened as a safe-haven asset, while the euro has reversed its year-to-date rally.

Strategic Asset Allocation and Hedges

  • Goldman Sachs Research has increased weightings in cash, commodities, and risk assets (equities).
  • Energy sector equities are favored as a hedge due to high cash flow yields, low valuations (trading ~40% discount to broader market on P/E), and sensitivity to rising commodity prices.
  • Macro hedges include the US dollar and Japanese yen.
  • Specific FX recommendations include the Canadian dollar as a resilient G10 currency linked to commodity exports.
  • Investment-grade credits, particularly those energy-related, are viewed as resilient in the current environment.