Ukraine’s battlefield gains are good for markets

The war in Ukraine has fallen from the headlines, and most analysts think the fighting will persist well into 2023, if not longer.

But what if the war ends sooner? What if Ukrainian forces repel the Russian invaders and put an end to the fighting? That would be a major upside surprise for financial markets—and it might not be as fanciful as it once seemed.

Ukrainian forces have gone on the offensive in at least two different places, and they seem to be routing Russian units that are even weaker than six months of botched operations would suggest. Near Kharkiv, in the northeast, Ukrainian troops have retaken perhaps two dozen villages from the Russians and advanced towards the key logistical hubs of Kupyansk and Izium, which they may soon capture. That would disrupt Russian supply lines to other key parts of the front.

“Ukrainian successes … are creating fissures within the Russian information space and eroding confidence in Russian command,” the Institute for the Study of War reported on Sept. 8. “Ukrainian forces’ relatively quick speed of advance and ability to shell [Kupyansk] are creating panic in rear areas.”

There’s another offensive near Kherson, in the southeast, where Russia has massed forces in anticipation of a move Ukraine has been telegraphing for weeks. Russian resistance may be stronger there, yet Ukraine may still have trapped several thousand Russian troops on the west side of a river they cannot retreat across, because of Ukrainian strikes on bridges and ferries. Ukraine ultimately aims to retake Kherson, which is a regional capital and crucial foothold for Russia in its effort to control Ukraine’s Black Sea access.

The momentum shift could have big implications

These advances do not mean Russia will be pulling out of Ukraine any time soon. Russia still has tens of thousands of troops dug in in eastern Ukraine, and its bloodthirsty leader, Vladimir Putin, won’t easily give up his misbegotten claim on his neighbor. The Russians can still rain artillery down on Ukrainian cities and reach just about anywhere in the country with long-range missiles.

Ukraine’s President Volodymyr Zelenskiy meets US Secretary of State Antony Blinken during his visit in Kyiv, Ukraine September 8, 2022. Genya Savilov/Pool via REUTERS

But the momentum shift, if it lasts, could have several weighty implications. The first is that it validates billions of dollars in military aid provided to Ukraine by the United States and other allies. President Biden and other world leaders who have been approving such aid had no idea, especially at the beginning of the war, if it would make a difference or merely delay an inevitable Russian takeover of Ukraine. US intelligence initially thought Russia would take the country in a matter of weeks. The situation now, with Ukraine retaking ground and Russia on the run, indicates that Western aid has been decisive and completely appropriate.

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That will help keep the aid pipeline open, and maybe bring more effective weapons into Ukraine, if it might help beat the Russians for good. There’s still a lot Ukraine needs: tanks, fighter jets, more artillery and more precision munitions. The United States and other donors have been reluctant to send their best, most lethal gear, out of concern it might trigger some kind of grotesque retaliation from Putin, with nothing to show for it on the ground in Ukraine. But Ukraine’s over-performance on the ground makes the case for upping the ante: Russia remains the West’s most ominous adversary, and if Ukraine’s armed forces can tear its army apart, it makes sense to aid and abet them.

The broader implication is a possible end to the war itself, sooner and on better terms than might have seemed possible just a month or two ago. Again, it would be foolish to infer that some quick Ukrainian victories against depleted front-line Russian units will continue to play out as Ukrainians drive deeper and meet stouter defenses. But it’s also true that many analysts didn’t think Ukraine couldn’t even pull off what it’s doing now—blowing through Russian units despite training, manpower and weaponry shortcomings of their own.

The goals of economic sanctions

The multi-nation sanctions regime against Russia has two goals: One, punish Russia for its medieval behavior. Two, help Ukraine win by starving Russia of funds and technology it needs to prosecute the war. But the most effective way to accomplish that second goal, helping Ukraine win, is through military aid, and the more the better. If Ukraine beats Russia militarily, the need for sanctions diminishes.

Russian President Vladimir Putin attends the plenary session of the 2022 Eastern Economic Forum (EEF) in Vladivostok, Russia September 7, 2022. Sputnik/Sergey Bobylev/Pool via REUTERS ATTENTION EDITORS - THIS IMAGE WAS PROVIDED BY A THIRD PARTY.

Russian President Vladimir Putin attends the plenary session of the 2022 Eastern Economic Forum (EEF) in Vladivostok, Russia September 7, 2022. Sputnik/Sergey Bobylev/Pool via REUTERS ATTENTION EDITORS – THIS IMAGE WAS PROVIDED BY A THIRD PARTY.

Some sanctions are relatively easy to impose, because they cause little or no collateral damage and don’t generate political opposition at home. Limits on technology sales to Russia, for instance, do not have any effect on technology purchasers in the United States or Europe. The tougher sanctions are the ones that trigger Russian retaliation or require some sacrifice in the countries imposing the sanctions, which, as we have learned this year, mostly involve energy.

It’s easy for the United States to ban Russian energy imports, as Biden did earlier this year, because we have plenty of domestic energy and easy access to world markets. But it’s way harder for Europe, because of its deep reliance on Russian oil and natural gas. Europe is on the verge of an energy catastrophe, because Russia has shut down its main gas pipeline to Europe, and may stop gas sales altogether over the winter. A plan for Europe to boycott Russian oil goes into effect on Dec. 5 and could cause another spike in petrol and diesel prices. Putin is deliberately causing as much pain as possible for Europe, and that is roiling energy markets worldwide. It’s possible that exorbitant energy prices in Europe this winter could cause a wave of bankruptcies and a kind of contagion from the energy sector into banking and other areas.

The sooner Russia loses, the sooner global energy markets can get back to normal. If Russia withdrew tomorrow, some sanctions would remain in place, perhaps for a long time. One major question at the end of this war, assuming Ukraine prevails, is how Russia will pay reparations, which could total hundreds of billions of dollars, for all the destruction it has caused. Sanctions will probably be one way to divert energy revenue or other sources of cash from Russia’s coffers to Ukraine’s.

But the United States and Europe could quietly end sanctions that impose costs at home. Europe should reduce its dependence on Russian energy no matter what happens, and almost certainly will. But a pathway back to some European purchases of Russian energy would bring down record-high prices and calm global markets. An end to the war might also obviate the need for a complicated US plan to impose price caps on Russian oil, to reduce the energy revenue Putin is using to fund his war. That plan may be the best way to keep oil markets stocked while throttling the revenue flowing to Russia. Of course, Russia will undoubtedly resist and enforcement could be a nightmare.

The Russia-Ukraine war may be far from over. But it could be the beginning of the end for Russia. The sooner it ends on the battlefields, the sooner the stress will ease on just about everybody, including most Russians. Victory for Ukraine, whenever it comes, will be victory for everyone else bearing the cost of Russia’s hostility.

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