Ukraine Peace, U.S. Troop Withdrawals and Trump NATO Threats

EZ Equities initially rallied on hopes of a Ukraine peace/ceasefire deal, but uncertainty is high on both the terms of a deal and the U.S. level of security for European countries in the next decade. With the situation so fluid, we just want to provide an illustration of some of the main European security scenarios.

Figure 1: European Security Scenarios   

Source: Continuum Economics.  A 4 scenario is that Putin (72) dies of old age in the next few years and is replaced by a weak leader that is less regionally aggressive.

EZ Equities initially saw a rally on hopes that a Ukraine peace deal could reduce geopolitical uncertainty and gas prices (via cheap pipeline gas from Russia).  The situation is however more complex on the initial question of a Ukraine peace deal and the wider European security question.

Our baseline has been for a Russia-friendly ceasefire and potential peace deal for Ukraine (here).  Events since last week have cemented that view.  President Donald Trump and other administration officials favors no U.S. peacekeeping, no NATO membership/no full restoration of pre-2014 borders.  European attempts at a peacekeeping force have failed to reach consensus and is unlikely given Russia opposition -- also note that the 1999 Kosovo peace deal was bilateral and sidelined Europe initially.  One unanswered question is what security arrangement Ukraine would get for signing the mineral deal if that occurred.  It seems to economic security listening to U.S. Treasury secretary Bessant (here), which would deter Russia rather than military security guarantees.  Ukraine President Zelensky has been left fighting a rearguard action.  A ceasefire or peace deal would likely still see information warfare by Russia to destabilize Ukraine, but with only a modest to moderate risk of the military war restarting in the next 12 months. Additionally, in most scenarios we would see Putin’s Russia taking 3 to 5 years to rebuild economic and military resilience, before putting pressure on any other country in Europe.

However, this does not guarantee a weak overall European security situation (Figure 1).  If Europe makes concessions to the U.S. in terms of increased defense spending and buying more U.S. goods in the coming U.S./EU trade war (here), then it is feasible that a controlled U.S. troop withdrawal could be seen that still keeps U.S. broad commitments to NATO.  Though European politicians are currently angry, they will adjust to the new reality in geopolitics from the Trump adminstration.  Trump support for Poland this weekend is an important signal (here).  U.S. defense secretary Hegseth is planning an 8% reduction in the defense budget (here), which would include troop withdrawals from Europe and the Middle East.  Meanwhile, it is highly likely that the Trump administration will reverse the 2022 surge in U.S. troop numbers in Europe undertaken by president Joe Biden. If this is accompanied by European coordination of procurement and buildout of defense manufacturing then it could make European partners a more cohesive force under a NATO umbrella – Hungary’s leaning to Russia means that the EU is not a vehicle for military coordination, but this would allow possibly vital UK participation. 

The 2 scenario is a deterioration in the European security environment, with the U.S. scaling down troop numbers and military assets more aggressively in Europe.  Though this could occur for the Asia pivot and defense spending cuts, it could also be driven by Trump’s deep dislike of multilateral organizations (e.g. EU and NATO) and disdain of certain European countries.  It could well be that threats along these lines emerge in the coming months from Trump.  If the main rationale is Trump mistrust of the EU and NATO, then this could crucially undermine the strength of NATO article 5 and the deterrent threat that NATO countries, led by the U.S would come to the rescue of anybody under attack.  If the U.S. is less than 100% committed then it would lead to debate on whether the U.S. would defend Baltic countries if they ever came under attack by Russia. If not, would other European countries be willing or able to defend a NATO country being attacked by Russia. The situation could be made worse if European countries fail to commit to better procurement/manufacturing and purchase of critical systems that only the U.S. military in Europe currently has available.  

The 3 scenario is a worse case whereby Trump decides to withdraw from NATO, perhaps on a pretext that European countries will not commit to a 5% spending target.  Though the U.S. Congress would fight back, it is still a low to modest probability scenario circa 5-10% rather than a tail risk. Trump could then ask other individual countries to pay the U.S. annually – note that Japan pays 75% of the cost of U.S. Okinawa bases.  This would also allow Trump to pick and choose preferred countries e.g. UK/Italy/Poland and Germany -- but possibly not Baltic states. European countries would then have no choice but to rapidly expand military spending to 5% plus of GDP, given decades of underinvestment means that the absence of U.S. security would expose vulnerabilities everywhere in Europe.  The vacuum could encourage Putin to restart the Ukraine war on any pretext or demand that NATO troops are withdrawn from the Baltics states, Poland and Romania – Russia previously made this ultimatum to the U.S. and NATO in December 2021 (here) and again the Saudi Arabia talks.  Some military strategists see Lithuania being most at risk, given it surrounds Russia Kaliningrad to the south.  All of this would open up a debate on whether European countries without a U.S. security guarantee would require an extra risk premium in their equity markets and for government bond yields.         

We shall return to update these scenarios as the Ukraine war and European security situation develops over the coming months and quarters.