The market opened this morning with a familiar jolt of geopolitical risk. Ukrainian drones struck the Moscow region overnight, killing three people, according to Russian officials. The Kremlin responded with the usual rhetoric of escalation, but the City is watching the bond market for signs of genuine panic.
This is not the first drone strike on Russian soil, but it is the deadliest. For the markets, the key question is whether this represents a strategic shift by Kyiv. Are they now willing to take the fight to the Russian capital with lethal force? The immediate reaction in gilts was muted, but traders are pricing in a higher probability of a Russian retaliatory strike on Ukrainian infrastructure.
Let’s look at the numbers. The Russian ruble weakened 0.5% against the dollar in early Asian trading. The MOEX index is expected to open lower. But the real action will be in the European gas market. Any disruption to Russian supply, either actual or threatened, will send TTF futures soaring. The UK is less exposed to Russian gas, but the spillover effects on inflation are undeniable.
Investors should brace for volatility. This is a classic risk-off event. Defence stocks will rally, energy stocks will be mixed, and the flight to safety will support US Treasuries and gold. The dollar will strengthen, which is bad news for emerging markets already struggling with debt.
But let’s not overreact. War is terrible, but markets have a remarkable ability to absorb bad news. The key is whether this is a one-off or the start of a new phase. If Ukrainian drones become a regular feature over Moscow, the Kremlin will have to respond. That could mean more mobilisation, more sanctions, or worse.
The bottom line: This is a reminder that the war is not going away. Fiscal discipline in the West is already strained by defence spending. Central banks will be forced to keep rates higher for longer to counter any supply shocks. The Bank of England is already walking a tightrope between inflation and recession. This will not make their job easier.
For now, the market is taking a deep breath. But the risk of a serious escalation is real. I would recommend hedging portfolios with gold and short-dated government bonds. Avoid overexposure to Russian assets, obvious, but also to European energy stocks that are too correlated to Russian supply.
The coming days will tell us whether this is a blip or a game-changer. Either way, the cost of capital flight out of the Eurozone just went up.
