Bracing for Escalation in Ukraine

If markets no longer expect a quick settlement, they aren’t pricing in an expansion of the conflict either.

With the Middle East’s many conflicts in negotiations and tensions around Taiwan still only simmering, investors may prefer to focus on the risks from Washington: trade wars, debt dynamics and the next Fed chair.  But there’s trouble afoot in Ukraine that may soon send shock waves through global markets as Russia’s attacks escalate and Western sanctions tighten. 

Last Thursday’s meeting between Secretary of State Marco Rubio and Sergei Lavrov in Malaysia highlighted the standoff, but concealed the rising risks from Vladimir Putin, Donald Trump, the U.S. Congress, NATO and Ukraine itself.  Trump himself has promised a Russia-related announcement later today, and no one is betting he’ll be carrying an olive branch.

The risks from Putin are hardest to explain.  Amid mounting battlefield casualties, stagnating economic growth and persistent diplomatic isolation, the Russian president should have embraced Trump’s offer to negotiate a ceasefire.  It’s hard to imagine anyone offering a better deal than an end to U.S. military support for Ukraine, a relaxation in sanctions, and a fresh start in U.S.-Russia relations.

But as attractive as this off-ramp should have been, Putin drove right by.  Beyond a few polite calls with Trump, he has escalated his attacks on Ukrainian cities, perhaps hoping Ukraine would cave as the U.S. backed away.  Following America’s attack on Iran’s nuclear sites, Putin has plenty of advisors cheering him on.

We’ll find out more later today, but Trump himself seems poised to escalate.  While he may wish he could walk away from two Eastern European enemies unwilling to compromise, he is beginning to understand that Ukraine’s fall now would be a personal humiliation and a strategic American defeat.  Much as the president has tried to blame Joe Biden for allowing the war to start, any outcome that sees a European democracy subjugated by an autocratic neighbor will fall in Trump’s chapter of the history books.

A war that once looked consigned to the list of frozen conflicts looks like it’s heating up again fast.

This explains the renewed military supplies for Ukraine last week and the expletives for Putin.  Just how much Trump may actually expand support for Ukraine remains to be seen, given the isolationist strains among some of his supporters.  But he won’t want to be accused of lukewarm support for Kyiv that merely prolongs the killing, either. 

If Trump does arm the Ukrainians more vigorously, he will find enthusiastic support in Congress.  In a famously divided legislature, there is overwhelming bipartisan support for a bill that will deliver its own sharp escalation to the conflict.  Co-sponsored by Republican Lindsey Graham and Democrat Richard Blumenthal, the legislation threatens 500% tariffs on countries that buy Russian oil, gas, uranium or other exports.

If passed next month as the sponsors hope, the new law could be more disruptive to markets than anything that has happened since Trump’s “Liberation Day” tariff threats.  China and India are Russia’s main energy clients, and this bill could trigger a collapse in their exports to the U.S. or a spike in the oil price as they seek other suppliers.  Or both.

Europe’s fresh commitments to its own defense will bring additional fuel to this escalation.  Promises at last month’s NATO Summit to spend 5% of GDP on defense are padded and ambitious, but they mark a direction of travel that Russia cannot ignore.    

While the buildup will be slow, the immediate efforts by European governments to back Ukraine’s defense look anything but phlegmatic.  Some $24 billion in additional military support announced in April includes air defense, missiles and other gear to fill any gaps left by Americans.  Conversations between French President Emmanuel Macron and U.K. Prime Minister Keir Starmer on closer cooperation of their nuclear forces may seem largely symbolic, but it’s a symbol that casts a shadow all the way to Moscow.

It may not be quite right to say the Ukrainians are gearing up for escalation after more than three grinding years of fighting.  But with Russia’s attacks growing more intense and Western support gathering fresh momentum, the fighting seems likely to expand before it winds down.

Last-minute diplomacy is always possible, as we have seen in the Middle East, but it would take a quick pivot by Putin.  More likely, the Donbass battle lines face escalation and expansion.  Russia may suffer a new economic blow if even only some of its oil and gas exports are interrupted.  And the global economy faces risks of a sharp spike in the oil price, jumpier European bond yields and a damaging interruption in key trade flows.   

Odds of a Russian attack on Poland or the Baltic states remain low, as does any talk of nuclear weapons entering the equation, but a war that once looked consigned to the list of frozen conflicts looks like it’s heating up again fast.