The conflict between Russia and Ukraine has had a significant influence on global financial markets.

Presumably, the tepid response reflected the fact that many thought the conflict would play out in much the same way as Russia’s annexing of Crimea back in 2014. It was a brief struggle, with limit ed involvement by the West, and with the end result that Russia carved out another piece of Ukrainian territory. But things have not played out as this relatively optimistic scenario might have suggested. Instead, things have been far worse, and they could yet deteriorate further. Financial asset prices are catching up to this reality, but there could still be some more catching up to do.

Perhaps ironically, the most likely conclusion to this conflict is that Russia will indeed carve out a piece of Ukraine, as it did with Crimea. But that did not seem to be its early intention, as it appeared as if it was going for the whole country on the assumption that it could wipe out the Ukrainian government pretty quickly. It has only subsequently turned its attention to the east and south of Ukraine because its bigger ambitions seem to have failed.

The response from the West has also been far more significant than that which we saw during the annexing of Crimea in 2014. And now it seems the situation could get worse on this front as the West pushes home its advantage to try to inflict huge losses on Russia’s military and its economy. In essence, the West has seized its chance to go after Russia, and this, of course, has made Russia more belligerent. The signs of this are coming from many directions.

One is the possibility that Russia is trying to destabilise the disputed region of Transnistria in Moldova, which borders Ukraine, to create a pretext to "liberate" this region.

Another sign of Russian belligerence is the decision to cut off gas supplies to Poland and Bulgaria this week because the pair would not meet Russia’s demand to be paid for gas in roubles.

And thirdly, there is the regular threat by Russian politicians that the country could be backed into using significant deterrents against the West—including the nuclear option.

Investors might see these nuclear threats as empty ones. They may also believe that Russia will soon start to re-supply gas to Poland and Bulgaria, and won’t restrict supplies to bigger EU countries like Germany. They could be right, but our view is that, even if these things don’t deteriorate, it is appropriate that asset prices take a much dimmer view of the conflict and its global consequences. For a start, it makes the task of policymakers all the harder, and this creates the risk of significant policy mistakes. Stagflation might have seemed an anachronistic term from the 1970s, but not now that the conflict has compounded price pressures and damaged growth prospects. European countries, in particular, are at high risk of falling into a recession, if only briefly, and that was not on most investors' radar screens when this conflict first broke.

The increased seriousness of the situation is certainly filtering into the FX market. This is because the dollar is surging against all significant currencies, even those that often play safe-haven roles in times of stress, such as the yen and the Swiss franc. This could be an ominous sign, for while strength in the likes of the yen and the Swiss franc often reflects unwinding carry trades, when it is the dollar that’s pushing all aside, it reflects more than just carry trade unwinds.

In our view, it reflects a primal demand for the safety and liquidity that, arguably, only the dollar can provide. What we need to look out for from here is whether we see signs of financial fragmentation, such as a rising cost of procuring dollars through the FX market, wider credit spreads, much higher sovereign CDS prices, spread divergence within euro zone bonds and much more. So far, the evidence does not convince us that the conflict in Ukraine will prompt such fragmentation, but things could get a lot worse—and probably will.