There are suggestions the Russian advance in Ukraine has proceeded more slowly than had been anticipated. Against this background, Russia’s military action seems to be intensifying.
Meanwhile, sanctions, including exclusion from the Society for Worldwide Interbank Financial Telecommunications (SWIFT)1 bank payment system, are inflicting serious economic damage on Russia.
On the ground, there are already reports of long lines at ATM machines and difficulties using debit and credit cards. We’ve also heard of queues in food stores because Russians anticipate shortages.
Global supply disruption continues to be a threat. There’s a possibility that energy sanctions may be brought in should fighting escalate further. Last weekend’s sanctions made it clear that the EU is more hawkish on Russia than previously anticipated. And higher energy prices could have widespread global economic implications.
In addition, Russia produces just under half of the world’s global palladium, which is critical to the automotive industry. It also accounts for around a quarter of global titanium supply, which is vital for industries including aerospace. The conflict could also exacerbate supply-side bottlenecks in these materials, along with others like aluminum, platinum and chemical gases, which are vital to semiconductor production.
One key area to watch will be the impact on agricultural production. Russia’s agricultural exports (mostly wheat and corn) are likely to come off the market. Ukraine’s could, too, if the conflict disrupts farming and crop yields.
Other major agricultural producers, such as Brazil and China, rely on Russia for about 20% of their overall fertilizer imports. If this shortfall can’t be made up from elsewhere, agricultural production in those countries could be affected too.
Higher prices in these areas would likely slow economic growth and stoke inflation. We’ll factor all of these price moves into our baseline inflation forecasts.
Higher prices in these areas would likely slow economic growth and stoke inflation.
The ongoing conflict, of course, has many implications for markets. Below, we break down a few of the high-level impacts the crisis in Ukraine could have on different asset classes.
Equities – focus on fundamentals
In response to the crisis and as a result of the economic sanctions put in place against Russia, many investors have sold off their Russian holdings. The equity market in Russia has taken a hit as a result, prompting a several-day market closure — the longest in the market’s history.2
Looking ahead, there will be an indirect impact on other economies, especially in the form of higher prices for energy and other commodities, as previously discussed, as well as increased volatility and risk.
As ever, we would caution against reading too much into short trading periods. Liquidity and panic can have a major impact, which is perhaps unwarranted by fundamentals. Prudent investors would do well to focus on long-term goals rather than give in to short-term panic and headline-induced fears.
Fixed income – mounting inflationary pressure
While the current crisis is likely to stoke supply-related inflationary pressure, we don’t yet know how it might affect central bank monetary policy.
The reality is that low interest rates globally are completely at odds with tight labor markets and soaring inflation. So, the conflict, while terrible, isn’t currently enough to deter central banks from raising interest rates, which for bonds is the biggest near-term danger.
Credit markets have repriced significantly since the conflict began, as they move to reflect the known impacts. Credit spreads have now reached a level of the mid-cycle corrections of 2015 and 2018. After those historical periods, credit markets saw positive returns in the following 12 months. So we’ll be keeping an eye on credit-market performance in coming months.
Emerging market debt – sanctions hit Russian bond market hard
The escalating conflict has severely hit Russian and Ukrainian fixed-income assets and currencies. And the sell-off has been aggravated by investors’ generally overweight exposure to these markets.
Several restrictions have been imposed that affect emerging market debt (EMD) markets — Russian bonds in particular. For example, US and EU investors are now prohibited from buying Russian foreign-currency and local-currency government bonds in the primary market.
Certain Russian corporate/bank bonds are also affected. For instance, VEB Bank and VTB Bank have been added to the SDN list of sanctioned companies and individuals, and their US assets frozen.
Outside of Russia and Ukraine, market reaction to rising risks has been muted. History suggests most geopolitical events (including the Middle Eastern conflicts that threatened oil production) don’t leave a lasting impression on markets. We can view the situation in Ukraine in a similar light.
In all likelihood, this conflict will disrupt macroeconomic drivers worldwide, including those in developed markets where many economies rely heavily on Russian oil. However, much depends on the impact of further Western sanctions and whether there’s a lasting increase in global commodity prices.
Multi asset – conflicting forces on the global economy
Despite the unfolding conflict, we expect the response from central banks to be limited given inflationary pressures and the scope for additional commodity supply disruption. Our multi-asset team believes that there may now be more scope for differentiation across the interest-rate curve. The front end of the curve is likely to remain under pressure from the prospect of central bank rate rises, while longer maturities may fall to reflect additional risks to growth.
These conflicting forces on the global economy suggest that markets may experience a period of extended volatility, with the flow of news likely to remain unsupportive as additional sanctions against Russia are announced.
It’s very difficult to make accurate predictions when the world is simultaneously experiencing a combination of events — each one of which in isolation is beyond the experience of most investors.
However, the breadth of the multi-asset investment universe could be important in helping to limit downside and capture upside (where this is available) at a time when traditional sources of diversification may be less effective.
What to remember when it comes to investments
The situation in Ukraine is, to say the least, distressing on many levels. But when it comes to investing against this fast-evolving backdrop, we believe that fundamental analysis and valuation, as well as studying previous market behavior are of the utmost importance.
1 SWIFT is a vast messaging network banks and other financial institutions use to quickly, accurately and securely send and receive information, such as money transfer instructions.
2 Bloomberg, “Russia Keeps Stock Trading Shut in Nation’s Longest Closure,” March 4, 2022.
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