What would a dirty deal in Ukraine mean for markets?

Ukraine peace talks will kick off between the US and Russia in Saudi Arabia this week. Ukraine's representatives apparently will not attend. We think now is the time to prepare for an outcome that many have feared: a dirty deal that clearly favors Russia, and where Ukraine is left with insufficient security guarantees.

In this paper, we discuss two alternative scenarios, leaving the door still open for a more positive scenario - an acceptable deal - as well. Economic impacts would be different under these two scenarios. Under a dirty deal, we should be prepared for some European countries rapidly restoring energy trade ties with Russia. Migration back to Ukraine would be limited and appetite for reconstruction investments would be low. Under an acceptable deal, energy sanctions would remain in the short term, and we would see more migration and reconstruction. Europe would continue to invest in defence, regardless of the type of the deal.

Energy market is the key variable for the European economy. Under a dirty-deal-induced rapid sanctions relief, we expect particularly gas prices to fall, which would push inflation expectations lower. EUR/USD could see a short-lived lift in a knee-jerk reaction. In the rates space, a peace deal would be no gamechanger for the ECB but issuance by EU institutions would increase under both scenarios, lifting term premium and widening supra-ASW spreads.

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