We’ve already seen the war in Ukraine have an immediate impact on global equity markets. Let’s look at what might be to come.

Share markets have fallen in the first few months of this year, partly because of the war in Ukraine. That said, the falls have not been huge.

European equity markets fell by around 10 per cent after it became clear that Russia was going to launch a full-scale invasion and these falls have since been partly reversed.

The one exception, unsurprisingly, is that Russian markets have fallen much further. Russia’s equity market is down by more than 50 per cent since the invasion, and bonds have collapsed in value, too, as the central bank has doubled interest rates.

There are plenty of historical examples of wars which have affected financial markets, but it’s not easy to draw any simple lessons, because experiences have varied so much.

Extreme crashes

At the most extreme end of the spectrum – such as following the Russian Revolution and the Chinese civil war – equity and bond investors were completely wiped out.

Investors also generally lost a lot of their wealth during World War 1. However, in World War 2 they did much better, at least in the countries which were on the winning side.

More recent conflicts probably offer more useful clues about how the war in Ukraine will affect the markets – but these also suggest that the impact of conflicts varies.

Some examples are quite reassuring. Although there were big falls in equity markets following Iraq’s invasion of Kuwait in 1990 and after the attack on the Twin Towers in 2001, these were quickly reversed because it became clear that central banks would cut interest rates to support the economy.

A close parallel

But others are less reassuring. For the world economy, the closest parallel to the current conflict in Ukraine may be the Yom Kippur War of 1973.

Like the situation today, the Yom Kippur War took place at a time when inflation was already rising.

And like the Ukraine war, its most obvious impact was to raise commodity prices.

This meant that policymakers were not able to cut interest rates to help the economy through the crisis, because they needed to concentrate on fighting inflation.

In fact, the Yom Kippur War led to an even bigger energy price shock than we have seen this year – oil prices rose four-fold during 1973-74.

The 1973 conflict was followed by one of the biggest falls in global equity markets in history and falls in bond prices at the same time.

Overall, the war is likely to have significant effects on commodity, equity, bond, and currency markets. Perhaps the most clear-cut case is commodities.

Commodity prices may stay high

Oil and gas prices rose steeply during 2021, as the world gradually recovered from the pandemic, but they have both taken a further leg up since the conflict started.

The price of Brent crude has risen from US$80 per barrel at the beginning of the year to well over US$100 at the time of writing.

European natural gas prices had already risen much further – from below €20 per megawatt hour below last year to €90/MWh today – and the conflict has driven them higher.

In other parts of the world, natural gas prices have also risen, but much less steeply.

The prices of many other commodities have also been pushed up by the war.

Russia and Ukraine are among the biggest producers of metals such as nickel and palladium, as well as agricultural commodities including wheat and potash (used to make fertilisers).

Prices of all these commodities have shot up and will likely remain higher for the foreseeable future. This will push up inflation and cause supply problems in factories and farms in Europe and elsewhere.

Bonds not as safe

Second, the war is likely to cause bond prices to fall, because interest rates will rise further than they would otherwise have done.

Bonds are usually seen as a safe haven when equity prices are falling, or in the face of bad economic and political news. But they may be much less safe than normal this year.

Yields were rising even before the Ukraine war started. Ten-year US Treasury yields rose from 1 per cent early in the pandemic to 3 per cent today and the equivalent German yields rose from a low of -1 per cent in 2020 to nearly +1 per cent today.

After declining when the war first broke out, they have since risen steeply because central banks have signalled that they will raise interest rates faster and further than previously expected.

Stock markets may stay low

Third, the war will have a negative effect on equity markets. The initial falls in US and European equity markets of less than 10 per cent were much smaller than the falls after 9/11 and the subsequent US invasion of Afghanistan, for example, and they have already been partly reversed.

But by pushing up interest rates and dampening expectations for growth, the war may result in equity markets remaining lower than they would otherwise have been.

Currency markets

Finally, the war is already having substantial implications for currency markets, most notably by strengthening the US dollar relative to European currencies. This makes sense given that Europe is much more vulnerable to the war due to how close it is to the conflict.

It is worth saying that wars that remain regional rather than truly global usually end up having only a limited impact on financial markets.

The big drivers of global markets this year are the hangover from the pandemic and the policy response to it, rather than the Russia-Ukraine conflict.

Also, the conflict has generally reinforced existing trends, rather than causing unforeseen changes in direction.