What has happened?

So it seems that the rather timid sanctions from the West were not a deterrent for Russian President Vladimir Putin. Perhaps they were even an incentive for him to move ahead and launch a full-scale attack against Ukraine, in what now appears to be the most dramatic security crisis in Europe since World War Two. Russian forces have even begun to target the densely populated capital city, Kyiv.

While Ukraine is a big country with an army previously ranked among the 30 most powerful in the world, there should be no doubt that Russia could rapidly control its airspace and destroy all key military facilities within days. The bigger question is: where will Russian ground forces and their allies stop their advance? A rapid blitz on key strategic targets would be the best-case scenario from the Russian perspective, as Moscow can hardly afford a long-term occupation and mass casualties among its armies.

However, we should be fully aware – with Mr Putin’s angry television speech in mind – that there is indeed a potential worst-case scenario where Russian forces come into direct contact with NATO troops. Such an escalation would undoubtedly have significant ramifications for markets, not to mention the potentially vast humanitarian costs.

What was the market reaction?

Early on Thursday, the S&P future was sharply down (-2.5%) and the Euro Stoxx future tumbled by more than 4%, while oil and gold were among the key safe havens bought by investors. Gas price futures are also spiking. This will likely hit the lower middle classes in most European countries hardest, leading to weaker growth, while potential blackouts could lead to production slowdown, also negatively impacting growth. Of course, this would also lead to higher inflation rates, as gas and gasoline prices continue rising and chemicals become more expensive.

The ECB will be in a difficult situation. Inflation numbers are already at record levels, which had led markets to speculate on interest rate hikes this year. Nevertheless, an increase in commodity prices is, in effect, a “tax” on production and consumption that would negatively impact growth. So, while inflation rates could continue to rise, the ECB may adopt a more bearish stance for the time being. Overall, rising commodity prices are set to result in weaker global growth and Europe would likely be the most affected region.

What does this mean for asset allocation?

Our Multi Asset Fundamental Investment Committee had already recommended increasing the allocations to safe havens such as US Treasuries and gold. Wednesday’s rather muted market reaction puzzled us, and so we think an even more cautious position in risky assets would be appropriate for the time being. We hold to our positive view on commodities, even though the market reaction could lead to some production support from OPEC.

Importantly, we are also watching for potential disruption to market liquidity, especially in Russian or Russian-related securities as these will be impacted – increasingly – by EU and US sanctions. The EU will prohibit the buying or selling directly or indirectly of any financial instrument issued on or after 9 March by the Russian government, its central bank, government agencies, or any person acting on their behalf. This means that Russia is now excluded from issuing new debt or refinancing its debt. Substantial outflows from any related Russian instruments could ensue, and there could be knock-on effects for widely used instruments such as ETFs and derivatives.

All in all, after a few years of solid performance for equities and other risky assets, this crisis may spur market participants to reduce their exposures over the coming weeks. We therefore continue to favour a cautious stance.

Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security.

The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the data is not guaranteed and no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted.

This material has not been reviewed by any regulatory authorities. In mainland China, it is for Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations and is for information purpose only. This document does not constitute a public offer by virtue of Act Number 26.831 of the Argentine Republic and General Resolution No. 622/2013 of the NSC. This communication's sole purpose is to inform and does not under any circumstance constitute promotion or publicity of Allianz Global Investors products and/or services in Colombia or to Colombian residents pursuant to part 4 of Decree 2555 of 2010. This communication does not in any way aim to directly or indirectly initiate the purchase of a product or the provision of a service offered by Allianz Global Investors. Via reception of his document, each resident in Colombia acknowledges and accepts to have contacted Allianz Global Investors via their own initiative and that the communication under no circumstances does not arise from any promotional or marketing activities carried out by Allianz Global Investors. Colombian residents accept that accessing any type of social network page of Allianz Global Investors is done under their own responsibility and initiative and are aware that they may access specific information on the products and services of Allianz Global Investors. This communication is strictly private and confidential and may not be reproduced. This communication does not constitute a public offer of securities in Colombia pursuant to the public offer regulation set forth in Decree 2555 of 2010. This communication and the information provided herein should not be considered a solicitation or an offer by Allianz Global Investors or its affiliates to provide any financial products in Brazil, Panama, Peru, and Uruguay. In Australia, this material is presented by Allianz Global Investors Asia Pacific Limited (“AllianzGI AP”) and is intended for the use of investment consultants and other institutional/professional investors only, and is not directed to the public or individual retail investors. AllianzGI AP is not licensed to provide financial services to retail clients in Australia. AllianzGI AP is exempt from the requirement to hold an Australian Foreign Financial Service License under the Corporations Act 2001 (Cth) pursuant to ASIC Class Order (CO 03/1103) with respect to the provision of financial services to wholesale clients only. AllianzGI AP is licensed and regulated by Hong Kong Securities and Futures Commission under Hong Kong laws, which differ from Australian laws.

This document is being distributed by the following Allianz Global Investors companies: Allianz Global Investors U.S. LLC, an investment adviser registered with the U.S. Securities and Exchange Commission; Allianz Global Investors Distributors LLC, distributor registered with FINRA, is affiliated with Allianz Global Investors U.S. LLC; Allianz Global Investors GmbH, an investment company in Germany, authorized by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors (Schweiz) AG; in HK, by Allianz Global Investors Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; ; in Singapore, by Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; in Japan, by Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business Operator [Registered No. The Director of Kanto Local Finance Bureau (Financial Instruments Business Operator), No. 424], Member of Japan Investment Advisers Association, the Investment Trust Association, Japan and Type II Financial Instruments Firms Association; and in Taiwan, by Allianz Global Investors Taiwan Ltd., licensed by Financial Supervisory Commission in Taiwan.

2052812