It looks increasingly likely that the US will engineer/enforce some kind of peace deal between Russia and Ukraine, whatever the Europeans might think about that.
You can see how investors have begun to bet on that in the rising price of GDP-linked warrants attached to Ukraine’s restructured bonds maturing in 2035 and 2024, which only pay out if certain conditions are met.
Goldman Sachs has helpfully translated the prices into a market-implied estimate for the probability of a peace deal that helps Ukraine rebuild its economy.
And although there are no details on what the truce/peace might entail, this means that analysts can at least begin to guess at the impact. Whatever one thinks about the political and geopolitical merits of a peace deal (and how Ukraine might get treated in the process) it’s been pretty clear for a while that this could end up being a major economic boon.
Goldman Sachs’ economists have mapped out the potential economic and financial implications of two scenarios, a more limited truce and slow resolution to the war over time, or an upside case with a “comprehensive and credible” agreement.
Here are their main conclusions, with FT Alphaville’s emphasis below:
– The most important channel would likely be via natural gas markets. Following our commodity strategists, we consider a limited gas flow scenario (with a 15% decline in gas prices) and an upside flow scenario (with a 50% drop in prices). We estimate that inflation would be 0.15pp and 0.5pp lower in the two scenarios, respectively, with a potential Euro area GDP boost of 0.1% and 0.34% via higher consumer spending and production.
– Consumer confidence dropped sharply across the Euro area with the onset of the war, pointing to the potential for a rebound with a ceasefire. Our analysis, however, points to small potential gains in confidence because we find that high inflation played a key role in depressing confidence in 2022 and measures of geopolitical risk have largely normalised. Our estimates imply modest confidence-driven gains in real GDP of 0.03% to 0.09% in our two scenarios.
– The reconstruction of Ukraine’s damaged infrastructure could also support growth across Europe. Combining our CEEMEA economists’ scenarios for rebuilding expenditure with plausible trade elasticities, we find a small Euro area GDP boost of 0.02-0.08% from rebuilding in Ukraine.
– The UN estimates that 2.6 million Ukrainian refugees have moved into the Euro area since the outbreak of the war. Following recent studies, we calculate that refugees have boosted Euro area labour supply by 0.4% and entailed public spending of 0.2% of GDP per year. Assuming that 15-50% of refugees return home following a ceasefire, we estimate a negative effect on Euro area GDP of 0.06-0.21%, with the biggest drag in Germany.
– The war in Ukraine tightened financial conditions across Europe, as markets priced the conflict as a risk-off event, with significant declines in equity prices and long-term bond yields. We assume that some of this tightening in financial conditions would unwind in the event of a ceasefire and estimate a Euro area GDP boost of 0.06-0.13%.
– Taken together, our analysis points to a potential Euro area GDP increase of 0.2% in a limited ceasefire scenario and a 0.5% boost in an upside scenario. Our analysis therefore points to a modest European growth upside from a ceasefire, unless a comprehensive peace agreement can be reached. Looking across countries, we estimate effects of 0.1% in Germany and around 0.2% in France, Italy and Spain in our limited scenario.
– Given the prospects of lower headline inflation and modestly higher growth, a ceasefire is unlikely to have significant implications for ECB policy. That said, we believe that the Governing Council would likely see through any mechanical drop in headline inflation and put more emphasis on diminished downside risks to growth, especially in the event of a comprehensive ceasefire agreement.
Peace should also help lift European equities, notes Barclays analysts. The UK bank’s basket of stocks that would benefit from Ukraine’s physical reconstruction has jumped again this week, and is now back at the high it touched when Trump was elected president.
But the benefits could be much broader, Barclays analysts argue, noting that conversations with American investors have indicated that many slashed their exposure to Europe when the war broke out, and could be willing to jump back in if it ended:
A significant ‘war risk premium’ remains across EU markets. EURUSD is c10% below its pre-Ukraine invasion level, while the cost of the war has inflated EU government deficits and fuelled stagflation across Europe, resulting in weaker growth and higher bond yields. So any progress towards a pause in the conflict may been seen as likely to ease the fiscal and economic burden on the region, in our view. However, we believe that defence spending will keep growing, with Trump unlikely to drop the pressure on NATO to increase defence budgets. More broadly, the performance gap between the stocks that went up the most after the conflict started, like defence and energy and those that fell the most, like airlines, leisure, chemicals and banks remains wide, although it has started to narrow. There could be more to go, and the crowded EU defence sector, which had a strong run, may see some profit taking. We think, however, that it would offer a buying opportunity, as the long term growth outlook for the sector remains strong.
Another thing to keep an eye on might be JEMA, or the JPMorgan Emerging Europe, Middle East and Africa Securities trust.
Until 2022 it was known as JPMorgan Russian Securities, but when Russia invaded Ukraine and got slapped around with sanctions the trust marked down the value of its Russian holdings to zero and rebranded itself. It’s still early days, but sanctions on Russia are also rolled back as par of a peace deal then those holdings will become pretty valuable, pretty quickly.
We’ll update this post with more analyst commentary as it lands.