How invasion could affect markets

A possible invasion of Ukraine by neighboring Russia would affect a range of markets, from wheat and energy prices to the region's government bonds and safe haven assets.

1/ SAFE HARBOR

Inflation, which is at multi-decade highs, and impending rate hikes have given bond markets a bad month, but an open Russia-Ukraine conflict could change that.

US 2-year Treasury yields posted their biggest monthly gain since 2016, and 10-year yields appeared to be heading towards the key 2% mark. In Germany, 10-year yields rose above 0% for the first time since 2019.

A major risk event usually sees investors rushing back into bonds, which are the safest assets on the planet, and this time is likely to be no different, even if a Russian incursion into Ukraine could hurt oil prices - and by extension the Inflation - could heat up further.

"Should things go wrong with Ukraine, there would be significant supply of government bonds and the notion that the 10-year bond could go up to 2% would be put on hold," said Padhraic Garvey, regional head of research for America at ING.

Other safe havens are gold, which has already hit a two-month high, and the yen.

2/ CEREALS AND WHEAT

Any disruption to grain flow from the Black Sea region is likely to have a significant impact on prices and further fuel food inflation - at a time when food affordability is a major concern around the world following the economic damage caused by the COVID-19 pandemic.

Four major exporters - Ukraine, Russia, Kazakhstan and Romania - ship grain from Black Sea ports that could be affected by military action or sanctions.

According to the International Grains Council, Ukraine is expected to be the third largest corn exporter and the fourth largest wheat exporter in the world in the 2021/22 season. Russia is the world's largest wheat exporter.

"In recent months, geopolitical risks in the Black Sea region have increased, which could affect wheat prices," said Dominic Schnider, strategist at UBS.

3/ NATURAL GAS AND OIL

Energy markets are likely to suffer if tensions turn into conflict. Europe gets around 35% of its natural gas from Russia, mostly via pipelines running through Belarus and Poland to Germany, with Nord Stream 1 running directly to Germany and others through Ukraine.

In 2020, gas supplies from Russia to Europe fell after lockdowns stifled demand, and failed to fully recover last year as consumption surged, helping to push prices to record highs.

As part of possible sanctions if Russia invades Ukraine, Germany has said it could halt Russia's new Nord Stream 2 gas pipeline, which it hopes will boost gas imports to the EU but also reduce Europe's energy dependency underlined by Moscow.

SEB commodities analyst Bjarne Schieldrop said that in the event of sanctions and gas prices rebounding to fourth-quarter levels, markets would expect a significant reduction in natural gas exports from Russia to Western Europe through both Ukraine and Belarus.

The oil markets could also be affected. JPMorgan (NYSE:JPM) said the tensions raised the risk of a "significant spike" in oil prices, noting that a surge to $150 a barrel would lift global GDP growth to just 0.9% in the first half year-on-year and inflation would more than double to 7.2%.

4/ REGIONAL DOLLAR BONDS AND CURRENCIES

Russian and Ukrainian assets will be at the forefront when markets are hit by potential military action.

Both countries' dollar-denominated bonds have underperformed their peers in recent months as investors reduced exposure amid escalating tensions between Washington and its allies and Moscow.

Ukraine's fixed income markets are mainly used by emerging market investors, while sanctions and geopolitical tensions have eroded Russia's overall standing in capital markets in recent years, somewhat mitigating the risk of contagion through these channels.

However, the Russian ruble and Ukrainian hryvnia have also suffered, making them the worst-performing currencies in the emerging markets universe this year.

According to Chris Turner, global head of markets at ING, the geopolitical situation on the Ukraine-Russia border poses "significant uncertainties" for the currency markets.

"The events of late 2014 remind us of the liquidity gaps and US dollar hoarding that led to a significant decline in the ruble at the time," Turner said.