War brings Europe closer than ever
In the face of extreme Russian aggression, the European Commission has begun to strengthen its economic and political mandates, says Morten Springborg, global thematic specialist at C Worldwide Asset Management in Denmark.
Speaking on the Soundbites podcast this week, Springborg said European nations have shown remarkable unity since Russian forces invaded Ukraine, and appear to be forging a new approach to defense military and economic policy.
“From a structural point of view, I think that we should not underestimate the cohesion that we are going to see in Europe. We are getting closer politically. And rearmament will now happen on an unprecedented scale,” he said.
He said the European Commission recently assumed the power to issue common denominated debt and is now talking about larger common defense policies, securing new sources of oil and gas and issuing a common debt to subsidize energy costs.
“This [military action in Ukraine] will automatically lead to much closer cooperation between fiscal and monetary authorities in Europe,” he said. “One of the effects of this long term is that Europe will grow, and countries that were previously opposed to deeper political integration will accept that it is inevitable. It will happen.
Meanwhile, the continent is caught in an economic vise as war rages on its eastern front.
“It’s probably quite risky to invest in consumer discretionary, consumer staples and financials today in Europe,” Springborg said. “Of all the major regions of the world, I would expect the probability of a recession to be highest in Europe.”
The continent has been particularly hard hit by high oil and natural gas prices, which “suck the purchasing power of ordinary Europeans”. Although the European Commission recently calculated that it could cut its dependence on Russian energy by two-thirds by the end of 2022, Springborg says that’s unlikely.
“I find that to be very, very unrealistic,” he said. “There is this assumption that we can just buy gas from international energy markets. But according to our sources, there is hardly any availability of cargoes that we could bring to Europe. So I think that’s very, very wishful thinking.
Springborg suggested it could take the better part of the next decade to wean Europe off Russian energy. “If we stay at these extremely high energy prices for, say, a quarter of a year, I would expect Europe as a whole to probably go into recession,” he said.
The European financial sector has also been hit hard since the outbreak of hostilities.
Springborg said investors had high hopes in the latter part of 2021 for a new era of reflation and an end to negative interest rates and quantitative easing – all of which would have benefited the financial sector. But now, with rapidly rising energy and food prices, the European Central Bank’s plans are likely to be put on hold.
“Markets are reflecting this by dropping financial stocks,” he said.
Another dangerous point is that some major European banks have ties to Russia.
“Loan portfolios aren’t necessarily that big, but there are banks in Europe that have very, very large derivative positions in commodity markets,” he explained. “It’s very, very difficult to know what the longer-term effects will be on commodity markets of the shutdown of one of the largest commodity exporters. We really don’t know how banks in Europe are exposed. to those kinds of risks, so that’s another reason why people sell financial products.
Springborg believes investor confidence will only return after a ceasefire.
“That would immediately lead to lower commodity prices, lower energy costs. And the cost of energy is a significant obstacle to European growth prospects,” he said. “We need to see a ceasefire and feel that stability is returning before we can talk about investors coming back.”
However, as difficult as the war had been against Europe, Springborg said much worse results would await Russia in the coming months.
“The Russian invasion of Ukraine is the greatest geopolitical event we have seen since World War II, and probably also one of the greatest own goals ever made by a Russian leader. Putin has, along with the invasion of Ukraine, probably ensured that the Russian economy would implode.
He said the sanctions against Russia could lead to hyperinflation there in the short term. Russia will be locked out of trade with the West – a fate that would cripple its war machine since many of its vital military components come from Western companies.
“Maybe that’s what will eventually stop the war in Ukraine,” he said. “Russia will simply be unable to sustain its efforts when it runs out of spare parts.”
This article is part of the Soundbites program, sponsored by Canada Life. The article was written without the contribution of the sponsor.