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Special market commentary: Markets rattled as Russia attacks Ukraine

February 24, 2022 Blog 10 min read
Jim Baird Wealth Management
As the world reacts to Russia’s attack on Ukraine, we provide perspectives on what these events mean for the global economy, policy, and the capital markets.

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Executive Summary

  • Within the last 24 hours, the conflict between Ukraine and Russia has intensified considerably as Russia launched widespread attacks across the country, reportedly striking major cities including the nation’s capital.
  • Geopolitical instability and the threat of war is always an unambiguous negative for sentiment, although the impact across global capital markets will vary significantly.
  • Inflation remains a concern for the U.S. and global economies and will likely be exacerbated by rising oil prices, but the economic expansion here doesn’t appear to be at risk in the near term.
  • Despite the recent uptick in the prices of oil and other commodities, the Fed appears unlikely to meaningfully deviate from their forecast path for now.
  • When conditions are particularly uncertain, investors should focus on the known rather than attempting to actively trade or make major strategy changes based on “what ifs.”

Recent events

Within the last 24 hours, the conflict between Ukraine and Russia has intensified considerably as Russia launched widespread attacks across the country, reportedly striking major cities, including direct strikes near Kyiv, the capital. The invasion clearly extends the hostilities well beyond the two breakaway regions in the Donbas region of eastern Ukraine into which Russia had stated that it would send peacekeepers. It also raises serious questions about Russia’s ultimate goal and increases tensions across Europe and beyond.

At times such as this, our thoughts go first to the people of the region, where many lives will be lost and countless more will be severely impacted as the full impact of war becomes clearer in the days ahead. Many are attempting to leave the country, creating a potential refugee crisis. We’re reminded again that the primary cost of war isn’t measured in dollars but in the human toll.

Still, we recognize our important role as your financial advisor to speak directly to what this means for the capital markets, which have experienced further volatility in recent days. While we watch alongside you as developments continue to unfold, we acknowledge the significant uncertainty around the geopolitical environment. In short, we can’t predict how events will unfold. What we can do is provide perspective about what these events mean for the global economy, for policy, and for the capital markets.

Market impact

We’ll first speak to the impact on the capital markets, where the immediate effects are most clearly seen and felt. Unsurprisingly, the buildup of tensions in recent weeks was already weighing on global equity markets as fears of a full-scale Russian invasion grew and investor sentiment deteriorated. The geopolitical crisis comes at a time in which risk assets were already under pressure in response to growing expectations for a more aggressive Fed response to inflation risk.

Geopolitical instability and the threat of war is always an unambiguous negative for sentiment, although its impact can vary widely across various markets, regions, and investments. It inherently creates a source of significant uncertainty, acknowledging that once a conflict commences, it’s impossible to know how it will play out or how unintended consequences could exacerbate conditions. As in past events, the immediate reaction has been for equities and other risk assets to tumble as investors, at least at the margins, seek safety rather than growth potential in the near term.

Geopolitical instability and the threat of war is always an unambiguous negative for sentiment, although its impact can vary widely across various markets, regions, and investments.

Having been under pressure for several months as yields rose in anticipation of near-term Fed interest rate hikes and quantitative tightening, Treasuries rose today and yields declined on the flight to quality, while the U.S. dollar increased moderately. Gold edged fractionally lower today, having rallied over the past month as geopolitical tensions rose.

Oil prices have now risen by about 20% in the past month and 50% since early December, as Brent Sea crude surged to nearly $106/barrel before falling back below $100. Higher energy prices have lifted the commodity complex, but will also have direct effects on inflation expectations, which we will address subsequently herein. Agricultural commodity prices rose sharply today in response to the likely disruption of wheat and other exports from Ukraine. In anticipation of additional sanctions imposed by the United States, the EU, and their allies on Russia, energy and industrial metals also moved higher.

European stocks closed down more than 3% on the day. Perhaps not surprisingly, the Russian stock market crashed, dropping more than 30%. In comparison, U.S. markets have held up comparatively well. By the end of the trading day, the S&P 500 recovered its earlier losses to rise about 1.5%, small caps were up about 2.6%, and the tech-heavy Nasdaq had gained 3.3%. Having opened lower, the intraday rebound suggests that some investors bought into the dip, with long-duration, non dividend-paying tech stocks benefiting from the decline in long-term yields.

The late day rally suggests that equity investors viewed the potential for a slower pace of Fed tightening as a positive development, rather than focusing on the deteriorating geopolitical environment. Whether that will continue remains to be seen. Global tensions could certainly escalate further in the coming days, but there is also still a tremendous amount of cash remains on the sidelines, some of which could continue to make its way into equities, supporting prices. Still, we believe that investors should be prepared for the potential that volatility could continue for some period as markets weigh developments and attempt to recalibrate expectations accordingly.

Economic impact

The economic impact of these developments will almost certainly be as diverse as today’s wide range of performance in global stock markets, with the greatest negative fallout likely borne by Russia and Ukraine. Given its proximity to the conflict itself, its greater reliance on Russian oil and natural gas, and its greater economic ties to the region, Europe could also be more directly impacted than other developed economies.

The direct effects on the U.S. economy are likely to be comparatively muted as neither Russia nor Ukraine represent major trade partners. In 2021, U.S. exports to Russia ($6.4 billion) and Ukraine ($2.5 billion) ranked 39th and 59th — and comprised a small fraction of the $208 billion of total U.S. exports.

Conversely, Russia benefited from nearly $31 billion of exports to the United States last year, largely concentrated in energy commodities, metals, and other commodities. Additionally, it’s worth noting that Ukraine’s economy is relatively small at about $155 billion in 2021. (For context, that would be comparable to the economy of Washington, DC or Nebraska.) On a global scale, it accounts for about 0.14% of global GDP. A war could devastate the region, but the global economic impact of even a protracted conflict is likely to be limited.

If there is a concern about the economic impact of these events, it’s clearly borne out in rising commodity prices in recent weeks. As noted earlier, Brent Sea crude breached $100/barrel for the first time since 2014, ironically in the aftermath of the Russian annexation of Crimea. Oil prices then plummeted by more than half as a boom in U.S. shale production, some easing in geopolitical tensions, and a willingness by OPEC to increase production alleviated those price pressures. It’s far too soon to predict how much higher oil prices could rise or how long prices could remain elevated. Much will hinge on the scope and duration of the conflict and on decisions yet to be made around economic sanctions that could be levied, as well as the ability and willingness of other producers to increase output.

It’s far too soon to predict how much higher oil prices could rise or how long prices could remain elevated.

The question is what impact higher commodity prices will have on inflation at a time in which concerns were already heightened. It’s important to note that a temporary spike in commodity costs has limited impact on growth, but a more sustained increase over an extended period would become a greater headwind. While estimates vary, in general terms, economists believe that a sustained $10 increase in the price of a barrel of oil would trim 0.1–0.2% off U.S. GDP. It could have a slightly more pronounced impact in Europe given its greater reliance upon imported oil and natural gas to meet its energy needs.

Directionally, that poses a risk that inflation pressures could remain elevated for longer than had been forecast but at this point doesn’t materially change expectations for those pressures to ease gradually over the coming year.

For now, the risk to the U.S. expansion appears to be limited. As this morning’s report on Q4 GDP confirmed, the economy grew at a brisk 7.0% pace late last year. It would take a significant slowdown to put the expansion at risk.

Monetary policy impact

That brings us to the Fed and the near-term outlook for monetary policy. Given what we know today, it seems unlikely that these events will prompt the Fed to materially alter its planned path. In recent weeks, many economists had been aggressively ratcheting up their forecasts for the number of policy rate hikes by the end of the year, with some of those projections easily outdistancing the Fed’s most recent forecasts.

If anything, these events will likely dampen those expectations, bringing them closer to the Fed’s own forecasts. The question that policymakers will ultimately be grappling with is the degree to which these events create an additional catalyst to sustain high inflation versus their potential to hinder growth. Both are risks. As of today, domestic conditions (high inflation, above-trend growth, and tight labor markets) point clearly to the need for the Fed to tighten policy via rate increases and curtailing their bond purchase program. At the same time, global developments can’t be ignored. The Fed will want to be careful to avoid tightening too aggressively if global conditions were to continue to deteriorate, creating greater risk to the global expansion.

The Fed will weigh all of these factors carefully as they strike a delicate balance in the execution of policy and their communication of future guidance. For now, we expect that policymakers will be undeterred, likely announcing a quarter-point rate hike in mid-March while providing reassurance that they remain focused on data and developments, standing ready to adjust as needed should changing conditions warrant doing so. It seems unlikely that the escalation of the conflict in Ukraine would cause the Fed to pause, nor would a near-term surge in oil prices seemingly be sufficient to cause the Fed to move to a 50 bp increase in March, which would represent an acceleration of its stated tightening plans.

What is the greater concern? If it’s inflation, the Fed will continue to hike rates. If a greater global growth scare develops, they will slow down their tightening pace. That balance puts the Fed between a rock and a hard place. But they are unlikely to adjust their response as a result of a spike in oil prices alone. An extended period of higher energy prices would require deeper introspection given the additional upward pressure on inflation and the effective sapping of consumer spending power as a form of tax on household discretionary income.

As of today, it still appears to be a foregone conclusion that the Fed will maintain its tightening stance though. For now, it’s not a question of if or even when but how quickly and how aggressively the Fed will act.

Next steps

When conditions are particularly uncertain, investors should focus on the known rather than attempting to actively trade or make major strategy changes based on “what ifs.” As always, we would advise investors to confirm their need for liquidity and replenish their cash reserve, if necessary, to meet any near-term obligations. Maintaining broad portfolio diversification also helps to mitigate potential downside from risk assets, while preserving exposure to stocks and other risk assets that can reverse course quickly as conditions stabilize and investor sentiment begins to turn positive again. Today’s sharp reversal in the U.S. markets illustrates that point once again.

It's also critically important to not lose sight of your investment time horizon. With sufficient cash to meet near-term needs, allowing your portfolio to remain invested while making targeted adjustments via rebalancing remains advisable.

We’ll continue to monitor developments closely as we evaluate what steps, if any, may be appropriate to consider. In addition to monitoring the news, we’re actively monitoring market conditions, our trusted industry resources, and are in communication with many investment managers to benefit from their perspectives as well. We’ll continue to evaluate the positioning of your portfolio and recommend any changes that we believe to be appropriate.

In the interim, please don’t hesitate to reach out to your advisory team with any questions or concerns that you might have.

Data sources for peer group comparisons, returns, and standard statistical data are provided by the sources referenced and are based on data obtained from recognized statistical services or other sources believed to be reliable. However, some or all information has not been verified prior to the analysis, and we do not make any representations as to its accuracy or completeness. Any analysis non-factual in nature constitutes only current opinions, which are subject to change. Benchmarks or indices are included for information purposes only to reflect the current market environment; no index is a directly tradable investment. There may be instances when consultant opinions regarding any fundamental or quantitative analysis may not agree.

Plante Moran Financial Advisors (PMFA) publishes this update to convey general information about market conditions and not for the purpose of providing investment advice. Investment in any of the companies or sectors mentioned herein may not be appropriate for you. You should consult a representative from PMFA for investment advice regarding your own situation.

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