Peace in Ukraine would give financial markets the boost they need in 2023

In addition to the massive human cost, the war has hurt global stability and growth prospects, wreaking chaos on energy markets
The introduction of a peace premium into expectations could easily lift global equity prices by the 20 per cent lost last year

David Brown

Published: 10:00pm, 2 Jan 2023

Why you can trust SCMP

The New Year is meant to signify a time of change and hope for better times ahead. 2023 will be full of challenges for world policymakers, facing the spectre of global recession, coping with tighter monetary conditions and dealing with higher inflation. Perhaps the greatest challenge of all in the short term is how to bring the war in Ukraine to a peaceful end.

It will be a tough task but imperative as the war has wreaked so much damage, not just in terms of the devastating human cost, but also the harm done to global stability, growth prospects and the chaos wrought on global energy markets.

The hope for 2023 is that both sides can reach an early ceasefire. It is the peace premium which has been long missing that could make a significant difference on many fronts in 2023.

In the run-up to the outbreak of the Ukraine war in February last year, the world had been making modest progress after the shock of the Covid-19 pandemic. Global recovery was coming back on stream, employment levels were recovering, inflation risks were a concern due to supply-chain shortages, but nothing that a return to more normal interest rate levels couldn’t handle. Stock markets in the US had reached record highs and global bond yields remained relatively subdued.

A year ago, at the end of 2021, the Organisation for Economic Co-operation and Development was cautiously optimistic for the future, projecting global growth at 4.5 per cent for 2022, moderating to 3.2 per cent for 2023 as loose monetary conditions were expected to be gradually tightened. The shock of war and the subsequent energy crisis changed all that.

Expectations for gradual recovery were quickly replaced by growing alarm about the future risk of global recession. Fears about Ukraine hostilities dragging on for a lot longer than anticipated and the central banks taking a much tougher line on inflation weighed heavily on sentiment.

Liquidity crisis could be global financial system’s ‘silent killer’ in 2023

A year on, by the end of 2022, the OECD had changed its mind with a much more downbeat assessment for global economic prospects, slashing 1.4 per cent off its estimate for world growth in 2022 down to 3.1 per cent, while knocking 1 per cent off its forecast for 2023 down to 2.2 per cent.

With confidence collapsing after the Russian invasion of Ukraine, global stock markets sank by around 20 per cent overall in 2022, with global bond yields surging at the same time. Ten-year US Treasury yields jumped by 2.2 per cent over the course of 2022 as the bear market raged for bonds.

As equity and bond market prices collapsed in tandem in 2022, could the first hint of detente in the Ukraine crisis be the rallying point for a return to risk-on trades in 2023? It might seem like an outside bet right now, but even early hints of better times ahead could be cathartic.

Global energy markets are already showing tentative signs of optimism, with natural gas prices recently dropping well below levels prevailing before the Ukraine crisis first broke.

Oil market tensions are easing too. The warmer weather and easier demand and supply conditions might have helped, but the price falls are also symptomatic of an expected easing of geopolitical tensions over the future.

Global stock markets may be focused on recession risks right now but the introduction of a peace premium into expectations could easily lift global equity prices by the 20 per cent lost last year, if not more. Much depends on how quickly global energy markets return to normal, but lower fuel costs could have a dramatic impact on inflation and interest rate expectations over the next few years.

Headline inflation is expected to ease during the course of 2023 due to year-on-year base effects, but dramatically lower energy costs could hasten the return to official targeted levels of 2 per cent inflation much quicker than expected over the next two years.

07:32

BIS chief Carstens: High interest rates to stay even if a US recession might be 'avoided' in 2023

Central banks like the US Federal Reserve and the European Central Bank could quickly find themselves out on a limb with unnecessarily over-tight monetary policies. US money markets are already discounting the possibility that the Fed could be cutting rates by the end of 2023. The same could be true for the ECB, which remains keen to reflate faster European recovery.

Falling inflation expectations, lower interest rates and the prospect of faster growth should be manna from heaven for equities and risk assets in 2023. Investors are craving a return to normality.

John Lennon was spot on when he challenged the world to give peace a chance. And never more so than now.

David Brown is the chief executive of New View Economics