The advent of a shooting war in Ukraine, if it happens, will likely stoke the already alarmingly high inflation level and push oil prices to over US$100 per barrel on the back of a possible supply shortage in Europe.

This warning was made by Mark Matthews, head of research, Asia-Pacific, at Julius Baer, who says that a military confrontation in Ukraine would affect global recovery in two ways. First, by making investors more risk-averse, and second, by resulting in an oil shortage in Europe which could push oil prices to over US$100 per barrel from its current level of US$87 per barrel. This would in turn stoke inflation, which already hit 7% in December 2021, its highest level since 2000.

“About 80% of Europe’s energy needs are imported and about 40% of that in turn comes from Russia, of which 16% goes through Ukraine. So either that flow from Ukraine could be cut off or stopped. I think you could see oil over US$100 in that scenario. So oil over a hundred dollars would make it much more difficult for us to say that inflation is going away and the Fed raising rates is not going to take oil back under a hundred dollars a barrel. That's a big political issue but it definitely means inflation,” Matthews says.

Financial markets are worried that the sudden spike in the inflation rate would push the Fed to step in and raise interest rates to higher than previously expected levels in order to slow down the US economy and bring down inflation.

“You can see that a survey done by Bank of America found that inflation and central banks being hawkish are the two biggest concerns because they go hand in hand,” Matthews says.

The Fed has been injecting US$120 billion a month into the financial markets to soften the impact of Covid-19 on the economy. There is now a sense that there may be rapid rate hikes and shrinking of the Fed balance sheet in order to address the rising inflation rate.

In terms of investment, Matthews says there are opportunities in Hong Kong based on the price-to-book ratio of the Hang Seng Index, which is extremely low relative to its history.

“I don't think the US is going to tighten as much as the market is pricing in, and I don't think that China's going to embark on some really aggressive quantitative easing programme. They're reluctant to do that so therefore you know you're probably not going to see the renminbi rising,” he says.

Also, the Canadian dollar would be interesting in the context of inflation because it is a commodity-centric currency. “In case there was trouble in Ukraine and the oil price went up some more, the Canadian dollar would be a very good hedge against that,” he adds.