Our scenarios on the war in Ukraine

Our analysis of the war in Ukraine is limited exclusively to the effects of the conflict on the financial markets. We distinguish between five possible developments that form our scenarios (see chart). In our base scenario, we assume a protracted war of attrition. The sanctions against Russia remain in place and cause temporary uncertainty, especially due to rising commodity prices. The impact on the financial markets decreases after initially great uncertainty. The focus of financial market participants is gradually shifting away from the war towards economic and interest rate developments. Thus, the high fluctuation margins of investments such as equities decrease continuously over time, at least as long as we remain within our base scenario.

Graphic: Overview of the five scenarios for the war in Ukraine

Source: Colin&Cie

A good example of the shift in investor focus was observed mid March when market partici-pants' attention turned to the Fed's updated interest rate outlook.

In the aftermath of the outbreak of the COVID 19 pandemic two years ago, the central banks have reacted in an extremely stimulative manner and supported the financial markets with suffi-cient liquidity. With the Fed meeting on 16 March 2022 and the first interest rate step, this period is coming to an end. In view of the high consumer prices (inflation of 7.9% in the USA and 5.9% in Europe), the central bankers are behaving extremely aggressively and expect seven more interest rate hikes of 0.25% each this year.

Market anticipates interest rate rise

According to our analysis, investors have prepared themselves for the coming interest rate steps. Based on futures market prices, market participants are already assuming six to seven interest rate steps by the end of the year. If this is indeed the case, no one will be surprised. So a lot is priced into current prices. Due to the coming economic slowdown, we expect fewer interest rate steps, which will ease the currently very heated interest rate discussion. An ad-justment of the historically close relationship between interest rates and the economy (see chart) and a decline in the leading economic indicator towards the end of the year (PMI falling) will result in a US interest rate level for 10-year government bonds between 2 and 2.5%, which largely corresponds to today's interest rate level.

Chart: Alignment in the historically tight relationship between interest rates and the economy argues for a US 10-year interest rate level of 2% to 2.5%

Source: Refinitiv Datastream

This has far-reaching consequences and ensures that especially bonds and, in the case of equi-ties, the technology and growth segments benefit. We are already well positioned in these market segments.

Outlook for the next 6 to 12 months

Due to the slowdown in economic momentum and the risks that still exist, we expect markets to remain volatile. Only with the prospect of better economic growth will there be a gradual improvement in the course of the third quarter. Financial markets anticipate such changes with a lead time of 6 to 12 months, i.e. the economic upswing from March 2023 will be anticipated by investors in the course of the third quarter.

After the rise in interest rates, bond yields have become more attractive again and we are in-creasing the allocation in the bond strategies and at the expense of liquidity. Equities are well supported at the moment by the very fearful sentiment and thus ready for a short-term recovery phase despite existing risks. We maintain our neutral position. Commodities and gold still show no exaggeration after the strong performance and are in long-term trend growth. In the first difficult months of this year, the portfolio stabilisation function of alternative investments has worked well. The outlook is neutral to positive.

Chart: Significant rise in yields to maturity in all segments makes bonds more attractive

Source: Refinitiv Datastream