Morgan Stanley
  • Research
  • Mar 9, 2022

Russia-Ukraine: Mapping Geopolitical Uncertainty

The conflict in Ukraine has already exacted a heavy toll. Though the outcome is unclear, the war will continue to weigh on global economies, with ramifications for central bank policy, energy, commodities and more. A look at the path ahead.

As 2022 began, the global economy appeared to be on a predictable course. With businesses reopening, labor tightening and prices rising, many central banks around the world were poised to begin unwinding the fiscal and monetary support they dialed up during COVID-19 pandemic.

Now, Russia’s invasion of Ukraine has dramatically changed many of these assumptions. It’s taken a human toll of tragic proportions, driven energy and food prices higher and created macro uncertainty around the world.

“Global inflation will be higher, and we see a direct drag on growth from higher commodity prices and possibly a further drag from uncertainty,” says Seth Carpenter, Chief Global Economist for Morgan Stanley Research. For the time being, global growth should remain solid in 2022 and policy tightening advances will likely continue, he says, “but more caution is clearly called for.”

Morgan Stanley economists have updated growth and inflation forecasts

Real GDP (%) CPI (%)
2022E 2023E Q4 2022E Q4 2023E
Global 4.6 3.9 4.4 2.8
U.S. 4.5 3.7 4.4 2.1*
Euro Area 3.0 2.3 5.3 2.3
Japan 2.3 1.4 1.7 1.2
China 5.3 4.7 1.9 2.2
Source: Morgan Stanley Research; *Based on 4Q/4Q

This sentiment is echoed by Morgan Stanley strategists, who believe market risks in 2022 will be front-loaded. Still, the outlook varies significantly by region and asset class.

“For those who are most negative on the market right now, the refrain is: Assets are still expensive relative to historical valuations; inflation is high and still rising; and central banks will need to raise rates to bring monetary policy back in line with the broader economy,” says Andrew Sheets, Chief Cross-Asset Strategist. “And yet, these concerns appear very different depending on where you look in the world.”

Morgan Stanley’s global research team is monitoring events in Ukraine and their implications, and updating their outlooks as the news unfolds. Here are regional macro and strategy observations based on the most recent events.

U.S. Outlook: Fed Expected to Stay the Course

Inflation was a concern even before the conflict in Ukraine drove up energy prices and other commodities. Now, the Federal Open Market Committee must decide whether to prioritize curbing inflation or supporting growth—and investors appear to be divided on which way the Fed will go.

Morgan Stanley’s take: “We think the Fed will prioritize growth over inflation, but to stay the course for now on its intent to begin the hiking cycle in March,” says Ellen Zentner, Chief U.S. Economist. She and her team have not changed their baseline assumption, which forecasts a series of quarter point (25 basis point) hikes, for a total of 150 basis points of tightening this year and an additional 100 basis points in 2023.

What the Ukraine conflict has changed is the team’s outlook for inflation and growth.  They lowered their forecast for real GDP this year to 4.5% and are now forecasting a 4.4% increase in Consumer Price Index inflation, up 40 basis points from their previous estimate.

Even before these developments, U.S. strategists thought equity valuations were too high—translating to a price target of 4,400 for the S&P 500 for the end of 2022—and recommended that investors be more defensively positioned. Recent events reaffirm this view and argue for an overshoot to the downside. “We think that multiples across the index have room to compress even after discounting the geopolitical developments of the last couple of weeks,” says Chief Investment Officer and Chief U.S. Equity Strategist Mike Wilson.

Morgan Stanley is forecasting a series of quarter-point U.S. rate hikes

Source: Morgan Stanley Research forecasts

Europe: Grappling with Supply Shocks

The Ukraine conflict has created a sizable supply shock for key commodities for much of the world—but pricing pressure is most acute in the euro area. The region relies on Russia for a significant share of its natural gas and oil—and Ukraine for corn and wheat, among other commodities.  

As a result, Morgan Stanley’s European economists have revised their inflation forecast up to 5.3% for 2022 and 2.3% for 2023.

The economics team has also reduced their base case estimate for GDP growth, from 3.9% to 3.0%, noting that Germany and Italy could experience the biggest impact. In addition to their bull, bear and base cases, the team added a fourth scenario—which considers a hypothetical cutoff of Russian oil and gas supplies into Europe. “The current situation is in many ways binary, with possible outcomes that are worlds apart,” says Jens Eisenschmidt, Chief European Economist.

For now, this doesn’t impact the team’s base case expectations for the European Central Bank’s plans to begin withdrawing fiscal support this spring and begin rate increases at the end of this year.

The Cross-Asset Strategy team’s key calls for Europe include moving to neutral duration for government bonds and the euro. Meanwhile, the European Equities strategy team believes price-to-earnings ratios are increasingly attractive and see relatively limited risk to earnings forecasts. “Downside risks have risen but we think it too soon to rip up our macro playbook for this year,” says Equities Strategist Graham Secker. 

Morgan Stanley economists think ECB rate hikes will begin in late 2022

Source: Morgan Stanley Research forecasts

Asia: Better Positioned, But Still Exposed

There are three primary channels by which Asia is impacted by geopolitical tensions elsewhere in the world—oil and commodity prices, financial conditions and corporate confidence, and trade.

From a macroeconomic perspective, most of Asia appears to be better positioned today than it was during previous periods of geopolitical tensions, thanks to better macro stability, fiscal room to respond and low inflation in many key markets. Prices in Asia are up a little over 2%, which is notable, given the 7% rise in the U.S. “The primary risk is that prolonged and heightened tensions curtail the capex cycle and weaken trade,” says Chetan Ahya, Chief Asia Economist.

Where the picture gets complicated is China. It also has the benefit of better macro stability, low interest rates and a manageable direct trade impact with Russia—which accounts for 2% of its exports and 3% of its imports, and policy easing is already underway.. Nevertheless, Morgan Stanley strategists recently adjusted their bear case targets to reflect a potential equity risk premium spike on further heightened concern towards China over geopolitical tension, a property market liquidity crunch and ongoing Omicron issues in Hong Kong.

Within Asia, Japan may offer the most upside to the team’s current base-case target; equities are trading at a growing discount relative to recent history, while there is potential for positive earnings revisions. 

CEEMA, CE3 and Latin America

Finally, the Central & Eastern Europe, Middle East, Africa (CEEMA) economics team has revised growth down and inflation up across the region given a deteriorating external growth environment and higher commodity prices. In the three Central European countries (CE3), Czech Republic, Hungary and Poland, economists expect downside shocks to exports, since Russia is a main trading partner. With headline inflation likely to accelerate from an already high level, they think central banks will focus on financial stability in the near term.

In Latin America, sizable and lasting commodity shocks are likely to lead inflation to exceed Morgan Stanley’s current economic forecasts. While this means rates could move higher, the region’s growth may be only mildly impacted; it’s main trading partners are the U.S. and China.

For more Morgan Stanley Research on the economic and investment implications of the Ukraine conflict, ask your Morgan Stanley representative or Financial Advisor for the most recent macroeconomic and strategy updates. Plus, more Ideas from Morgan Stanley's thought leaders.