Positive signals from Russia-Ukraine talks boosted market sentiment this week. Media reports that Ukrainian and Russian negotiators are discussing a 15-point draft peace deal raised early optimism that the two sides could be approaching a diplomatic solution to the ongoing war in Ukraine. In our Research Russia-Ukraine – Updated scenarios and implications for commodity markets, March 9, we argue that the two sides are likely to eventually agree on a ceasefire/truce but that will require some painful concessions from the Ukrainian side. Despite a potential truce, some level of conflict/unrest is likely to remain but on a baseline we do not expect an escalation of the conflict outside Ukraine.
In our base case of a frozen conflict in Ukraine, we think the global economy will see weaker growth but escape a recession (see Big Picture – Headwinds to the global economy from Ukraine and Fed tightening, March 17). In a downside scenario, where there is an escalation of the war beyond the borders of Ukraine, the risk of recession in Europe increases significantly. With rising inflation, euro area consumers will see the biggest real income erosion in decades this year, and we revise down our 2022 euro area GDP forecast to 2.5%. The US economy is more insulated from the Ukraine war repercussions, but strong stagflation dynamics will keep the pressure on Fed to tighten financial conditions. Overall, we now expect US GDP growth of 2.8% this year. We have also postponed our expectation of a recovery in China and now look for GDP growth of only 4.7% this year.
As widely expected, Fed launched its hiking cycle on Wednesday by raising the Fed funds target range by 25 bps to 0.25-0.50%. Despite signalling six further rate hikes for this year, we still think Fed is behind the curve, and keep our call unchanged, expecting a total of 175bp hikes this year (25bp at each meeting but 50bp in June). We still expect an announcement on QT in May.
Risk markets recovered this week on the back of rising optimism around Russia-Ukraine talks. Equity markets gained in Europe and the US, and EUR pared losses against USD breaching 1.10 level. German and US 10y yields increased around 10bp as demand for safe havens took a breather. Commodity prices also backed off with Brent oil briefly visiting below USD 100/barrel and European gas prices hovering around 110€/MWh. Despite optimism around peace talks, we highlight that markets remain highly sensitive to headlines. Also, in the light of ever more aggressive use of force by the Russian army against civilians in Ukraine, we cannot rule out a further step-up of Western sanctions against Russia, and a potential further hit to the global risk sentiment.
In the coming week, focus will remain in Ukraine war developments and the peace talks. European leaders will meet for an EU-summit on Thursday-Friday, discussing the economic fallout from the war and possible fiscal support measures. The data calendar is light but we will keep a close eye on global PMIs on Wednesday. Particularly, we expect the renewed disruptions from the war on supply chains to be reflected in a dip in the euro area manufacturing activity.
