The Russia-Ukraine war has sent shockwaves around the globe. Many questions are being asked about what this means for geopolitics, existing alliances and treaties, and ultimately, what impact it will have on financial markets.
The initial reaction was a sharp sell-off in risky assets as investors favored classic safe havens like gold, the Japanese yen and the dollar. However, the reversal of these moves and the bounce back in stocks, which recovered their losses by the end of last week, saw markets virtually back to business as usual. But the situation remains hugely uncertain with new tougher Western sanctions once again hitting financial assets. Heightened volatility amid news and rumors characterizes the current environment.
Of course, markets are forward looking with historical precedent firmly in the sights of analysts and strategists who model and attempt to forecast events over the medium term. Indeed, a pattern of past geopolitical crises is that in the end, the underlying economic context tends to dominate. Allowing for any initial emotional shocks, sell-offs are relatively shallow with equity markets on average losing roughly six percent. These periods of volatility are also relatively short, lasting three weeks to trough, and then to recovery.
The swift revival in many markets did initially appear to reveal that investors seemingly judge that there is insufficient reason to believe this conflict will throw the global economy off course. And perhaps most crucial to this view is that sanctions have so far not bitten too hard into Russia’s commodities trade. But markets have reacted badly to the new, tougher restrictions, as these will impact not only Russia, but also potentially Europe itself, if energy prices continue their surge higher.
The underlying issue for investors remains tighter monetary policy and with it, rising price pressures which may increase in energy and gas markets. This means the crisis would add further support for already punchy inflation which has risen to multi-decade highs in recent months. The flip side to the geopolitical shock is that it may also act as a potential shock to growth. That is the key conundrum and balancing act that needs to be answered in the next few weeks.
In general, commodities had already been pricing in a fairly large risk premium as tensions escalated. This is not a surprise considering how important Russia and Ukraine are in these markets and is especially the case for crude oil, natural gas, palladium, nickel, aluminum, corn and wheat. The chief concern is that sanctions could disrupt export flows of these commodities, at a time when several of these markets are already tight and trading near multi-year highs.
Oil prices have followed a similar pattern to other risk assets, with prices of Brent crude spiking by $9 to $105.74 before paring these gains late last week. The higher price environment suggests that the US could take further action to increase supply, potentially with a further release of oil from the Strategic Petroleum Reserve. The US will also likely pile on the pressure for OPEC to increase its output more aggressively at its meeting on Wednesday.
Hussein Sayed, Chief Market Strategist at Exinity.
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