Whichever region you look at, domestic policy is starting to be felt further afield. The last 12 months has seen multiple events ripple through markets and global supply chains including China’s regulatory crackdown on the technology sector (July 2021), Turkey’s devaluation of the lira (November and December 2021), and Russia’s invasion of Ukraine.

But it is the last of these events that has served as a reminder that the balance of power among countries is relevant once more. Crucially, open conflict between nation-states is no longer inconceivable. In the longer-term, this raises the risk that de-globalisation could accelerate.

The bottom line for markets: investors will continue to diversify away from Russian assets, and we may see that investment diverted towards large, systemically important emerging market economies instead. We are also likely to see greater wariness around investing in regions that could become geopolitical flashpoints in the medium-term. Currencies in stable western countries (where interest rates are also rising) could also benefit.

China’s stance on Russia’s invasion of Ukraine raises difficult questions that could have a huge influence over how the country is perceived globally. How it balances its role as an aspiring international superpower that both supports its close allies and respects national sovereignty will be crucial. In the near term, China looks to be distancing itself from the conflict while also volunteering its services as a mediator between Russia and Ukraine, though that offer has yet to be taken up by both sides.

Meanwhile, Russia continues to pursue closer ties with China, where it could stand to benefit from greater bilateral trade, particularly in energy, and potentially greater regional clout. Though Russia’s reliance on China for trade is far greater than China’s on Russia, greater bilateral trade could have big implications for yuan valuations, and in the longer-term, potentially reopen the path to the currency’s internationalisation. More widespread use in key commodity markets and trade finance could one day lead global central banks to use the CNY for reserve diversification. But for that to occur in practice, China’s tight grip in the form of capital controls would need loosening.

The bottom line for markets: we think China will seek to remain neutral over the conflict, with stability again being a core strategic aim. But the right balance between supporting Russia, an ally, while not antagonizing the west may be tough to strike. Still, if more bilateral trade with Russia is on the cards, it will lead to greater pressure for more widespread use of the CNY.

The war in Ukraine has challenged America’s broader foreign policy stance in two important ways: first, it’s steadfast adherence to international institutions and trade – rather than force – as the primary domain for action on the world stage looks shakier given the events currently unfolding; second, its focus on longer-term “strategic competition” with China while expanding the role of regional allies seems to be giving way to shifting priorities. This could have big implications for China, depending on how it reacts in the months ahead. We see three possible options:

1. China treads carefully: with Russia increasingly isolated – and that isolation acting as a warning to other countries that buck global norms – China will continue navigating closer ties with the country while attempting to avoid international censure. This remains our base case.
2. The US gets distracted: in much the same way that the ‘War on Terror’ took the US focus away from China’s international rise in the 2000s, America pivots towards Russia, giving China freer rein to expand its influence elsewhere.
3. Western solidarity coalesces around China: the US and its allies could instead find renewed impetus to defend the trade and institution-based world order, pushing back more forcefully on China – and nudging it more forcefully into forming regional trade and diplomatic alliances.

The bottom line for markets: both scenarios 2 and 3 could lead China to pursue more regionalised trading and data-sharing arrangement, leading to “near-shoring” and the splintering of prior global network effects (news, financial transactions, or even the internet). This could also lead to a significant appreciation of the CNY as regional allies seek alternatives to the US dollar. Still, we think scenario 1 is likeliest of the three; it is the least costly or confrontational.

The biggest takeaway and potentially the greatest risk for markets is that, were much of the above to come to fruition, it would only serve to exacerbate the current trend towards regionalisation and de-globalisation.

For companies, de-globalisation will likely lead to increased supply chain disruption. It may push rising prices higher yet, and should prompt companies to continue strengthening their supply chains. After two years of muddling through a global pandemic, many have of course already prioritised the resilience of their supply chains in the face of cacophonous and abrupt global lockdowns and reopenings. Rising geopolitical tensions only serve as a reminder that global supply chains will continue to face pressure for some time, adding urgency to those de-risking efforts.