Global rout of equities not related to Ukraine tensions, more downside to follow in case of escalation

New Delhi, Jan 27 The current global rout in risk asset prices is not related to the tensions around Ukraine. In case of an escalation, investors therefore need to brace for more downside, foreign brokerage, UBS said in a report.

Past market drawdowns driven by similar events have been short-lived, however.

UBS said should the crisis worsen, Europe's energy security would represent a key risk to markets in our view. The threat or reality of supply disruption of hydrocarbon flows could lead to their prices to rocket.

Global energy markets are already tight, making near- to medium-term substitution near impossible. That said, energy continued flowing from Russia to Europe even at the height of the Cold War.

The West's threat to disrupt financial transactions with specific Russian counterparts or even the Russian economy as a whole would lead to significant disruption in cross-border business and difficulties settling Russian external debt.

Such sanctions could also interrupt energy flows, as they may de-facto prevent payment flows for received fuel deliveries.

For Russia, a tightening of the sanctions regime would likely reduce its long-term growth potential further, with negative consequences for the living standards of the population and the return outlook for Russian assets, UBS said.

A full-scale invasion of Ukraine by Russian forces is a tail risk event, in our view. Should it occur, it would trigger risk-off sentiment among investors and tough sanctions against Russia.

Energy flows, commodity prices, and the ability to execute cross-border transactions would be in focus. Energy supply disruption,whether as a result of sanctions, a Russian decision, or accidents, could have a longer-lasting impact. However, both parties seem keen to avoid such an outcome, in our view, UBS said.

Tensions around Ukraine have escalated in recent weeks. Our base case is for a continuation of diplomatic efforts leading to a stabilization and an eventual easing of these tensions. This may take several months, during which flare-ups remain possible, for example as a result of actions taken by the separatists in Ukraine, Russian special forces, or cyberattacks.

All of these could trigger countermeasures by Western countries. In this scenario, we see any aggression staying below the threshold at which it would trigger the full range of threatened sanctions, with a thin margin of overstepping thresholds from either side, UBS said.