Ribbons in the colors of the Ukrainian national flag are tied to the cannon of a destroyed tank on display in central Kyiv. (UBS)

War in Ukraine: No end in sight

Russian offensives in Ukraine mostly stalled. The Russian army's efforts to gain territory in the Donetsk region has reportedly resulted in high costs and little progress. Ukraine, meanwhile, was able to liberate parts of Kherson oblast after a counteroffensive that targeted Russian supply lines and effectively used military support from its allies. With momentum on its side, Ukraine has not signaled a willingness to start negotiations with Russia. The Russian leadership, too, has not convincingly portrayed a readiness for genuine negotiations, nor has it expressed any qualms about annexing Ukrainian territories in September. We therefore don’t foresee a negotiated settlement to the conflict any time soon and expect the war to continue well into next year.

That said, the status quo is unsustainable in the long run. Casualties of military personnel and civilians are mounting. Ukraine’s energy infrastructure has been heavily damaged by Russian missile strikes, and its economy is expected to shrink by more than a third this year based on IMF forecasts. The partial mobilization in Russia and defeats on the battlefield are weighing on the mood of the population. Ukraine’s backers have to rationalize financial and military aid to their own populations in the middle of a cost-of-living crisis exacerbated by the effects of the war. And many nations who previously stayed neutral have become more outspoken against a further escalation in the war.

Base case: Prolonged war caps Eurozone growth

Incompatible war objectives and demands mean that it may prove too difficult to find a resolution to the conflict that all sides can live with. While hostilities may subside even without an agreement due to fatigue, no resolution would create a situation where hostilities can break out at any time again, perpetuating the conflict’s potential to weigh on sentiment for even longer than our tactical horizon. We expect the war to continue well into next year without a negotiated settlement. Efforts toward negotiations may intensify at some point in 2023, for example if the strain for Ukraine’s backers of continuing financial and military support becomes more difficult to bear. Still, we expect support for Ukraine to hold up as long as its army is willing and able to fight, with a focus on liberating territories lost since February. Similarly, we expect trade between Russia and its economic partners to continue, boosting its commodity exports to countries like China, India and Turkey, thereby generating revenues and retaining access to goods imports. We expect the crude import ban to weigh moderately on Russian output in December, with a bigger impact expected when the European import ban on refined products comes into force on 5 February.

Europe will most likely continue to depend on suppliers like Norway, the US, and LNG spot cargoes for its gas consumption in the years ahead. This will likely come with a sizable price tag: Natural gas prices in the Eurozone are likely to remain much higher than pre-invasion levels in 2023 and higher than prices in the United States. Higher prices are needed to draw LNG to the region, and they may rise even higher if demand from China recovers as COVID restrictions are rolled back. But higher gas prices would likely encourage lower usage by Europe’s industrial users and consumers, boosting efficiency, and spur investment into developing renewable energy, as well as demand for other fossil fuels such as coal in the near term. To be sure, we expect Europe to manage the 2023 refilling season without government mandated gas rationing. But with higher prices and ongoing uncertainty, we expect the Eurozone economy to grow at a below-trend rate next year.

Investment implications

We expect the investment outlook in the coming months to be shaped by high but likely moderating inflation, uncertainty about the terminal rates central banks may be content with and weakening economic activity. We believe investors should continue to be positioned defensively in such an environment.

For more on the upside and downside scenarios as well as key investment recommendations, see the Global Risk Radar: How to position in view of the war in Ukraine, 8 December, 2022.

Main contributors: Tilmann Kolb, Dirk Effenberger, Giovanni Staunovo, Dean Turner, Thomas Flury, Matthew Gilman, Strategist, Claudia Panseri

Content is a product of the Chief Investment Office (CIO).