February saw the unwelcome Russian invasion of Ukraine, bringing war back to Europe for the first time in 30 years. Besides the ongoing unnecessary loss of life, the conflict has tragically displaced millions, causing one of the largest humanitarian crises in Europe in a generation.
A Russian Bear Market
Russia invades Ukraine.
West imposes massive package of sanctions on Russia.
Commodity prices spike – Brent oil hits 10-year high of $122 and gold hits an 18-month high.
In UK, England ends all Covid-19 rules by the end of February.
Cost-of-living crisis - higher energy bills, petrol prices, food inflation could hamper growth.
UK inflation hits a 30-year high at 5.5%.
European inflation hits an all-time high of 5.8%.
US inflation hits a 40-year high at 7.5%.
China manufacturing recovers in February.
OPEC+ to stick to planned modest uplift in oil production despite energy crisis.
Putin’s move wrong footed many, but perhaps surprisingly, has resulted in a united and forceful response from the West, with sizable sanctions and military support to the Ukrainian military. Even prompting Germany to materially increase defence spending and announce its intention to send weapons to Ukraine. This is arguably one of the biggest shifts ever seen in Germany’s post-war foreign policy.
The immediate financial fallout was most pronounced in Russia, where the currency collapsed and the stock market fell some 30% before being suspended. It is yet to reopen. However, the growing risk of a drawn-out conflict, coupled with a partial buyers strike for Russian commodities, and heavy sanctions, has seen certain commodity prices explode higher.
In particular, the ramifications for energy commodities have been extreme. Oil is up over 50% since the start of 2022, coal some 250%, and gas nearly 400%. In addition, Ukraine is a very important source of a number of food and metal commodities, which have also seen sizable increases, such as the c.65% rise in the price of wheat.
As such, this backdrop provides further fuel to the inflationary fire. Something which was already putting central banks under significant pressure, as they negotiated the tight rope of managing inflation and normalising policy. Central bankers now effectively find themselves on a tight rope in the middle of a storm, with more severe inflationary pressures in the short term, accompanied by a deterioration in economic growth prospects.
Even though the key focus for most central banks continues to be inflation, in an environment of heightened uncertainty, central banks may become more cautious, which means a less aggressive rate hiking cycle. Having expected a 0.5% interest rate rise in March from the Federal Reserve, market expectations now point towards a rise of 0.25%. However, it’s worth noting that the Fed has not felt it appropriate to raise interest rates by more than 0.25% in a single meeting this century.
Government bond yields saw some exceptional movements, with the US benchmark 10-year bond yield trading above 2% for the first time since 2019, given the expected path of interest rates. It subsequently fell back to 1.8% on Ukrainian developments and general risk aversion.
Recent economic data relating to the period prior to the invasion had been robust, reflecting the diminishing impact of covid and the substantial financial stimulus. In addition, the employment backdrop had been very strong, with house prices buoyant. That said, commodity price changes of this magnitude are hugely damaging economically. Politically, there will be enormous pressure to shield electorates, both from fuel and food prices, particularly in poorer countries. Such an action, at least in part, would help to offset the impact of central banks tightening policy.
Whilst the UK and US equity markets appeared little phased into the month-end, volatility has steadily increased during the conflict. There is a high degree of uncertainty as to how this crisis concludes and over what time period. Nevertheless, it seems reasonable to expect that global growth will be impacted, given the increase in energy prices, as well as the damage to sentiment.
Whilst we are mindful of geopolitical uncertainties, the current backdrop can present substantial opportunities for long-term investors.
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