What does Russia’s invasion of Ukraine mean for markets?
Amid the ongoing tragic events unfolding in Ukraine, in this rolling "live" article we look at what has happened, review potential scenarios, and market implications.
Please note, this live blog is no longer being updated. Please check Schroders Talking Point for our latest market views.
Today’s high inflation is being compared to the 1970s. However, robust consumer spending, fuelled by pandemic savings, makes for a different set of circumstances.
Keith Wade, Schroders Chief Economist: “We have a risk scenario where Russia continues to occupy Ukraine and turns its attention to its new neighbours prompting tensions with Eastern Europe (Poland, Romania, Hungary, Slovakia) and the Baltic states.
“The rise in commodity prices then drives inflation even higher putting a major squeeze on consumers and business. Economic activity slows significantly. The result is an even more stagflationary outcome with global growth weaker and inflation higher this year and next.”
Read the full article here.
Capital punishment: private sector sanctions in Russia
Read the full article here.
The corporate response to Russia’s invasion of Ukraine is representative of a wider shift in the role of the private sector in society, according to Portfolio Manager and Sustainability Specialist Katherine Davidson.
“We have seen swathes of companies announce that they are withdrawing from or suspending operations in Russia, as well as companies proactively donating products or services to the war effort…
"In the past, companies generally tried to stay out of politics and avoid taking any stance that might alienate segments of their customer base. Nowadays, there is more reputational risk in a lacklustre response or – even worse – radio silence… The events unfolding in Ukraine are reprehensible. Investors, regardless of their views on ESG, should be doing their (small) bit by holding multinational companies to account regarding their behaviour in Russia.”
Has the Ukraine war sped up the clean energy revolution?
As energy security rises up the political agenda, Isabella Hervey-Bathurst examines what Russia's invasion of Ukraine means for climate change investing.
"President Putin’s aggressions have triggered a rapid and fundamental reshaping of European energy policy, with energy security now the continent’s primary concern. In the short term, all options are on the table, including extending the use of coal-fired power generation and potentially intervening in the carbon market.
"However, this should not be taken to mean that the energy transition has been side-lined: far from it. Perhaps it has taken Putin’s appalling war and the new energy security imperative to finally catalyse an energy revolution."
Read the full article here
What impact has the Ukraine crisis had on eurozone shares?
Simon Corcoran, Investment Director, UK & European Equities, and Nicholette MacDonald-Brown, Head of European Blend Equities, discuss how the crisis has affected eurozone equities, with a focus on three sectors: banks, utilities and carmakers. Read the full story here.
"From an investment standpoint, eurozone shares have so far lagged other markets since the invasion.
"The underperformance of the eurozone relative to other regions over the last two weeks has been sharp and swift. A partial recovery came on 9 March as energy prices eased and traders bet that EU leaders would take action to limit the economic impact of Russia’s invasion of Ukraine.
Why have eurozone equities underperformed?
"The underperformance is largely due to growth fears, given the region’s geographical proximity to the crisis and fears around higher inflation. The surge in oil and gas prices is threatening a sharp rise in costs for European industry. Airlines, shipping companies, carmakers and other energy-intensive industries are notable examples.
"The chart below highlights the sharp sell-off in cyclical companies (those most sensitive to the ups and downs of the economic cycle) within Europe relative to companies considered more defensive."
Is Russia the new Iran as a result of sanctions?
Economist George Brown examines what impact Western sanctions will have on Russia’s economy and compares it with the experience of Iran.
"Russia is now the most sanctioned country in the world following its illegal invasion of Ukraine, which has brought misery to millions. More than 2,000 additional Western sanctions have been brought in against a broad range of individuals, corporations and institutions. It seems inevitable that Russia will suffer a deep recession.
Moscow had built a large $643 billion war chest and diversified its foreign-exchange holdings away from Western currencies to withstand external pressure. But the surprise moves from Western allies to freeze the Russian central bank’s foreign assets have rendered these largely useless."
Read the full article here
How do commodity prices impact emerging markets?
Kristjan Mee, Strategist, Schroders Strategic Research Unit:
"The commodity price shock, set off by Russia’s invasion of Ukraine, is reverberating through the global economy. In emerging markets (EM), the impact of sharply higher commodity prices is not uniform.
The figure below shows the net commodity exports as a percentage of GDP for 25 major EM countries. Around half of the countries have a positive commodities balance. For these countries, higher prices could actually be a net positive.
Unsurprisingly, Middle Eastern oil exporters are set to gain the most from higher oil prices, with oil exports making up a large share of these economies.
In Latin America, Chile and Peru are major exporters of industrial metals, most significantly copper. In addition, Argentina and Brazil are large exporters of agriculture products, such as wheat and corn.
In Asia, most countries are net commodity importers. Wealthier Asian countries, including China, should be better equipped to weather the price shock. Less developed Asian countries, however, such as India and Pakistan, are clearly more vulnerable to higher commodity prices.
Similarly in EMEA (Europe, the Middle East and Africa), the most vulnerable are lower income countries that are dependent on commodity imports. For example, before the war, Egypt imported of 80% its wheat from Russia and Ukraine.
Turkey, a large oil importer, could also face difficulties, with its annual inflation exceeding even 50% before the commodity price shock."
New Investor Download podcast.
Commodities expert James Luke and Cazenove's Chris Lewis discuss whether investors will continue to head for gold and gold equities at times of uncertainty.
You can listen by clicking the play button at the top of the page or by subscribing to the Investor Download wherever you get your podcasts. New shows are available every Thursday at 1700 GMT.
Chris Lewis, Investment Director at Cazenove Capital: "I think when we look at the outlook for gold this year, a lot does depend on what our outlook is for growth. What we think the future path of inflation is going to be. How central banks are going to respond in terms of their policy movements. And also how Russia-Ukraine develops. There are quite a few moving parts, but just going through those our base case is that growth outlook does remain robust."
James Luke, Fund Manager, at Schroders: If you believe that gold has a role in your portfolio, and you believe you like the diversifying aspects of gold and you like the hedging proposition that it brings you, then it's probably not a bad idea to own gold equities as well. Because from a valuation perspective, the way I see it right now is gold equities have already priced in quite significantly lower gold prices, but you're paying nothing for any upside scenario in gold. So the risk reward to me looks very, very good.
Impact on credit markets
Our Head of Global Credit, Patrick Vogel has penned a piece looking at how corporate bonds markets have been affected by the conflict and how as an investor he is positioning for such a period of uncertainty.
It's available here.
"For bond markets, the conflict in Ukraine adds to what was already significant pressure. Government yields rose sharply earlier in the year, pricing aggressive interest rate tightening on the back of more “hawkish” central bank rhetoric. European yields have reversed earlier move considerably in recent days, but remain higher than at the start of the year..."
"...Given still overall favourable growth and strong company fundamentals we think there is scope for credit to stabilise and start to perform better in time. We retain our conviction in strong sectors and companies, with the characteristics to weather challenging circumstances..."
How Russia's invasion of Ukraine threatens global food supply
Felix Odey, Mark Lacey and Alex Monk, Global Resource Equities fund managers, consider the impact of the invasion and consequent sanctions on the already fragile food system:
"Russia's status as a key producer of agricultural commodities means there is a real risk of future food shortages. Russia and Ukraine together account for around 30% of the world’s wheat exports. Clearly, disruption to the export of wheat will have ramifications for consumers in terms of both availability and price.
"But the problem extends further because Russia is not only a large producer of wheat, but also of the resources that go into fertiliser products such as nitrogen, phosphate and potash. The potash market in particular is highly concentrated. 80% of all exported potash comes from just three countries - Canada, Belarus and Russia.
"The sanctions being imposed on Russia and Belarus by the West will disrupt the trade of these commodities, with a knock-on impact to crop yields in countries around the world.
"This comes at a time when climate change and extreme weather events are already putting pressure on agricultural land. In our view, creating a sustainable food and water system is one of the most urgent challenges facing the world today."
Read the full article here
The impact of Russia's invasion on the semiconductor industry
Prior to Russia’s decision to launch a full scale invasion, Ukraine accounted for in excess of 50% of global neon exports – a key input to semiconductor industry. This is an industry which was already seeing strong demand and supply pressures.
What does this mean for chip manufacturers, are there alternative sources, and how quickly can these be replaced?
Robert Ledger, Emerging Markets Analyst
“It’s actually quite unclear what the other sources of neon are at this point. Taiwanese companies – which are responsible for around 60% of global production - are aware this is a strategic input, and as such foundries have stated inventory of around six months. It’s expected, given the relatively low value add nature of the process, that production from other sources can be increased over that time. Most companies see this an issue of a short-term price spike that needs to be absorbed into their costs, rather than being worried about long-term supply.
“So I think the impact is manageable as it’s a few percentage points of cost of goods sold, and semiconductor companies currently have pricing power. Other sources should be found before inventory is wound down, but from precisely where is unclear at present. Generally you do not get the feeling there is a high level of concern from the semiconductors companies at this stage, but the situation is clearly fluid.”
How will the Ukraine crisis affect the energy transition?
Alex Monk, Mark Lacey and Felix Odey, Global Resource Equities fund managers, consider how Russia's invasion of Ukraine may affect energy transition investing:
"The situation in Ukraine adds further credence to the argument for transitioning our energy system to one based on cheap, clean, reliable power.
"However, we would stress that this does not change the near-term growth and earnings forecasts for companies. Indeed, they could potentially be outweighed by more prominent inflationary risks. Supply chains are still disrupted and it takes time for new demand and projects to come through."
Read the full article here
Schroders statement on Ukraine:
"Everyone at Schroders is shocked and deeply saddened by the Russian invasion of Ukraine. Our hearts go out to the millions of people affected, which include some of our employees and their families and friends.
Our exposure to Russia, Belarus and Ukraine is minimal at less than 0.1% of assets under management and we will not be investing in Russian or Belarusian equities for the foreseeable future. We will monitor the situation closely and will continue to take investment decisions to protect our clients’ interests.
Russian markets have been suspended. Our focus today is to examine our non-Russian holdings to understand how they are managing their businesses in Russia, Belarus and Ukraine, their supply chains and the stakes they may own or operate. We are engaging with those companies to ensure they are responding appropriately to the current crisis.
Aside from the human tragedy, this terrible situation will have significant long-term business implications which we are analysing. The provision of European energy supplies is likely to be dramatically different, the rising oil price has impacted inflation expectations, while global supply chains across numerous industries will need to be re-directed. We need to engage on these issues and many more in order to meet our client expectations on ESG and to most effectively manage their portfolios.
Finally, we know that our people at Schroders care deeply about what’s happening. That is why we as a firm have made a significant donation to support the Red Cross, as it seeks to provide food, medicine and shelter to the people of Ukraine. We will also double the donations made through our employee charitable giving scheme.
In these difficult times, our thoughts remain with Ukraine and its people."
How did the crisis affect global markets in February?
Sean Markovicz, Strategist, Schroders Strategic Research Unit, said:
“Markets tumbled in February as investors assessed the potential economic impact of sanctions on Russia — a key exporter of commodities.
"The UK was the best performing market because of its high exposure to the energy and materials sectors. Meanwhile, European equities were the worst performer – a possible consequence of the region’s heavy dependency on Russian energy imports.”
Our latest market review is available here
How might the crisis affect commercial real estate markets?
Mark Callender, Head of Real Estate Research:
"The human impact of the invasion of Ukraine is devastating and our thoughts are with the people affected.
"As real estate investors, we need to assess the market implications of the crisis and - in brief - we think that on real estate markets in western Europe its impact is likely to be limited.
"Most of the impact will be indirect via the economy in terms of slightly higher inflation, lower growth, and central banks being slower to raise interest rates.
"The war has added to inflationary pressures on energy and food prices, reflecting Russia’s importance as an exporter of oil and gas and Ukraine’s role as a major exporter of wheat.
"However, despite the acceleration in inflation, Schroders is still forecasting relatively strong economic growth this year of 3.3% in the eurozone and 4.3% in the UK, as pent-up savings provide a cushion for consumers against the impact of higher living costs.
"The direct impact of sanctions on occupiers and real estate investment markets in western Europe is likely to be modest. Russian cross-border investment in commercial real estate globally has averaged only €300 ($330) million per annum over the last five years (source RCA).
To put that in context, there was €340 billion of investment deals in Europe in 2021. Anecdotally, Russian investors have been more active in residential markets, particularly in London and Helsinki. The Ukraine real estate market is largely domestic, with very few international investors.
The crisis might lead to a slight shift in investor demand away from real estate in central Europe and towards markets which are perceived to be safe havens (e.g. London, Paris, Switzerland). The fall in 10-year bond yields since the start of the war in Ukraine adds support to the view we held before the crisis, that real estate in the UK and eurozone is fairly priced."
Ukraine crisis highlights Europe’s Russian gas dependency
Russia is facing the ire of the world following its illegal invasion of Ukraine, which is bringing misery to millions. It is also the second largest producer of natural gas in the world. In spite of efforts by European policymakers to manage the impact of energy price inflation on the end consumer, and business, options in the near term may be limited.
Azad Zangana, senior European economist
“The German government is trying to reduce the impact of higher oil and gas prices from Russia and wean itself off Russian energy a little bit more.
“As renewables got going, natural gas was always seen as a cleaner alternative among the fossil fuels, but clearly the option of imports from Russia is less powerful now.”
Russia removed from key emerging markets equities indices
As had been signalled in recent days, MSCI will remove Russia from its emerging markets indices, with the country moving to standalone status. The decision, announced last night, will take effect from the market close next Wednesday, 9 March, and at a price that is effectively zero.
Nicholas Field, Emerging Markets Strategist and Fund Manager
“Since the Russian invasion of Ukraine on 23 February, Russian assets have become uninvestable. Currency and equity markets in Russian assets are actually or effectively closed. What prices have been available for foreign-traded Russian equity show a mark down to virtually zero value.
“MSCI launched a consultation with international investors on 28 February, regarding the accessibility and investability of the equity market in Russia. Given that the market is neither of these things, MSCI have reached the inevitable conclusion the Russia cannot remain part of its indices.”
How is Schroders responding to sanctions?
Russia’s invasion of Ukraine has triggered Western sanctions, which affect the way we conduct our business.
Nigel Drury, Chief Risk Officer, Group Risk
“Russia’s invasion of Ukraine will have significant consequences. We are acutely aware that this has created a humanitarian crisis and our thoughts are with those who are directly impacted.
“These are clearly highly uncertain times, but we are hopeful that de-escalation is forthcoming.
“In the interim, we remain focused on assessing the market implications for clients. This is an evolving situation which we are closely monitoring, and we continue to assess the impact.”
Read more: How is Schroders responding to sanctions
New Investor Download podcast
Given the fast-moving situation in Ukraine we will try to provide, where we can, more regular audio updates on what is a humanitarian disaster and what may turn into an economic crisis and perhaps even worse.
In this episode Duncan Lamont, Head of Strategic Research, speaks with Keith Wade, Schroders’ Chief Economist, on the potential impact of Western allies’ sanctions on Russia and what might happen if Russia responds by turning of the oil and gas taps.
You can listen to the podcast by clicking the play button at the top of the screen or subscribe to the Investor Download wherever you get your podcasts.
What impact will Russia's invasion of Ukraine have on oil and gas?
Mark Lacey, Alex Monk and Felix Odey, fund managers in our Global Resource Equities team, have analysed the impact of the crisis on the conventional energy sector:
"Global energy markets were already tight. Years of underinvestment, coupled with incredibly strong demand, meant that oil and product inventories were in deficit, and gas inventories were in a significant deficit.
"Further investment in global gas markets will be needed over the next few years in order to diversify supply away from Russia, while at the same time causing the least disruption to industrial and residential users of energy. Because of the need to reduce coal-fired generation, natural gas still has to be used as a bridging fuel for the energy transition. Long-term security of supply has become ever more important.
"The events in Ukraine will speed up the energy transition. Energy independence through cheap and sustainable power will be at forefront of every policymaker’s decision-making process from now on."
- Read the full article here
What's happened to asset prices over the past week since Russia launched its invasion of Ukraine?
Sean Markovicz, Strategist, Schroders Strategic Research Unit, explains:
"Over the last week, there’s been a dash for inflation protection and safe-haven assets. Commodities (+8.3%) and US Treasury inflation-protected securities (+3.8%) have outperformed. Nominal US bonds (+2.2%) and gold have also done well (+1.4%).
"In contrast, broad-based emerging market assets have been shunned. Emerging market (EM) local government debt has fallen by 3.2%, while EM equities are down by 2.5%.”
Gold - the only "safe haven" asset?
James Luke, Metals Fund Manager, discusses how investors tend to turn to gold during times of market turmoil:
"Gold prices have risen amid the Ukraine crisis. However, as this shocking situation evolves, we think gold remains set to become the "TINA" (there is no alternative) safe haven asset.
"Besides looking for a store of value in times of heightened market stress, we believe many investors see the coming rate hiking cycle as extremely risky given the abnormal macroeconomic backdrop.
"The current uncertainties suggest that institutions are likely to continue to give more consideration to portfolio diversifiers such gold, as other choices look less appealing."
- Read the full analysis here
How stock markets perform after heavy falls
Stock markets have tumbled in the days following Russia’s invasion of Ukraine. To date the current crisis has seen major markets fall by approximately 10%.
Our analysis show what has historically happened in the period after such turbulence.
- Read the full story here.
Sanctions - what are the implications?
Keith Wade, Chief Economist and Strategist, has responded to the the latest sanctions announced on Tuesday morning:
“Sanctions could easily go further. These are not as severe as the sanctions that the West has put on Iran. With Iran, any bank with operations in the US was not allowed to deal with Iran and the Americans were pretty stringent on following up on those that did break those rules.
“This is one of those situations where you don’t have to put those sanctions on, you can just signal that they can follow. Western banks are unlikely to want to be involved in supporting trade with Russia or financing activity in Russia when more severe sanctions could be around the corner.
“Russia itself is not enough of a global player outside of oil to have too much of an impact. It’s an economy about the size of Italy, and accounts for about 3% of the eurozone exports, less from the US. Russia is not a driver of global demand but we could still see dislocations and liquidity problems in financial markets.
“However, a scenario of further escalation, with fighting intensifying, could create a lot of angst in the West and great pressure for more intervention. In this scenario we think the Brent crude could reach up to $150 a barrel. We could see similar percentage increases in food prices, adding to inflationary pressure, and that would have an impact on growth.”
Self-sanctioning Russian oil?
Kristjan Mee, Strategist, Schroders Strategic Research Unit:
"Russian energy exports have been so far largely spared from international sanctions. Only Canada has announced a ban on import of Russian oil.
However, the latest news reports indicate that companies have started “self-sanctioning” Russian oil. Since last Thursday, a number of financial institutions in Europe and China have already halted financing Russian commodity trade because of the uncertainty over sanctions. In addition, refineries in Finland and Sweden have ceased imports of Russian crude oil.
It seems that these steps are now starting to significantly impact Russian oil exports. According to Marine Traffic, a live data provider of global ship traffic, there has been a noticeable change in crude oil shipping patterns.
As seen in the link below, there are tankers still leaving Russia’s Baltic Sea ports around St Petersburg, but there are almost no tankers going the other way to pick up new cargoes.
This shipping route is crucial for Russian oil exports, as more than half of Russia’s oil passes through the ports of the Baltic Sea."
Analysis from our economists
Welcome back to our coverage of the Ukraine crisis. Our economists have just released their latest Economic and Strategy Viewpoint. Their full in-depth analysis is available here. But here's the summary.
"From a trade and finance perspective Russia is not significant enough to derail the world economy. However, the links through commodity prices are key and Russian aggression looks set to keep energy and food costs elevated. The fall in asset prices if sustained will also dampen global activity as will higher uncertainty.
In this respect, events in Ukraine add a further stagflationary twist to the outlook by pushing up inflation and weakening growth. The tightness of labour and product markets means that we were already heading in this direction.
We now expect global growth of 3.7% this year and CPI inflation coming in at 4.7%. In our previous forecast last November, these figures were 4% and 3.8% respectively. Significant downgrades to the Eurozone and UK account for the weaker growth forecast whilst inflation is revised up across the board.
We still expect pent up savings to provide a cushion for consumers against the increase in living costs to maintain spending and growth. An easing of supply chains and peaking in commodity price rises should also help ease inflation, as will a moderation and rebalancing in consumer demand as fiscal stimulus fades.
The Fed is still expected to tighten with lift off in March, but to move more gradually with four hikes this year. Recent events reinforce our dovish stance on the European Central Bank, who are not expected to move until later in 2023.
We continue to expect growth in emerging markets to slow and have trimmed our forecasts to 4.2% for this year and next. High inflation continues to impede activity and while we expect price pressures to ease in the months ahead, substantial interest rate hikes during the past year will increasingly weigh on growth.
Despite the changes to the global forecast, the risks are still skewed toward stagflation either through a wage-price spiral or an even greater escalation of the Ukraine crisis. The chances of rising prices triggering another recession, as in earlier cycles, have clearly risen especially as central banks have limited room for manoeuvre, given the high level of inflation and lack of economic slack."
EM Debt view
Nick Brown, Emerging Market Debt Fund Manager
“Markets are pricing in escalation and retaliation from Russia. But it’s also the uncertainty over the ability to trade in Russian assets. Today we’ve had the Russian Central Bank raise interest rates to 20%, and Russian companies now forced to convert 80% of their FX revenue back into roubles in an attempt to support the currency. Capital controls cannot be ruled out.
“The central bank is under pressure, we don’t know how much of the $630 billion in foreign-exchange reserves it has available now. Of this figure, 50% are in government or government-backed securities, 25% in deposits, and around 20% of that is in gold. Whether or not they can sell the gold reserves is also a question mark.”
Gas imports in Europe
Malcolm Melville, Fund Manager, on Russian gas imports to Europe:
“Europe is very dependent on Russia for the supply of gas.
“At the moment energy has not been included as part of the sanctions but if they were or Russia decided to reduce the supply of gas to Europe then this would put many European countries in a difficult situation.
“Gas supplies are low globally at the moment so it is hard to see where Europe could buy its gas from to replace the Russian gas it may lose. The impact on the European economies could be large.”
US bonds view
Lisa Hornby, Head of US Multi-Sector Fixed Income, gave her thoughts on the situation in bond markets:
“We may be past the peak in terms of market uncertainty. Sentiment indicators in the credit market, such as the Credit Suisse Panic/Euphoria index, had reached panic mode prior to the invasion of Ukraine. This suggests that investors had already mitigated risk levels to some degree. The market will continue to grapple with both the fallout of this crisis as well as the ongoing uncertainty regarding the speed of Federal Reserve (Fed) rate hikes, resulting in volatility. Despite these headwinds, we have started to see some opportunities open up in credit markets.”
Impact on commodities
Two of our commodities fund managers, Malcolm Melville and Dravasp Jhabvala, discuss the impact of the invasion on commodities:
“Looking at the commodities angle, it’s useful to see where we were going into this crisis. Broadly, commodity markets were already undersupplied. There is very little in the way of spare inventory.
“Russia is a key exporter of a number of commodities – not just oil and gas but also agricultural commodities.
“On the oil front, Russia produces about 10 million barrels per day (m bpd), of which it exports around 4.5m bpd. That’s in the context of a global oil market of around 100m bpd. China buys roughly 1.5m bpd from Russia – and will continue to do so – so that leaves 3m bpd in the balance, or around 3% of the global market.
“On the gas side, Russia supplies around 17% of the world’s gas. Some European countries – like Macedonia and Moldova – get 100% of their gas from Russia. Germany obtains 49% of its gas from Russia.
“The question is, what happens now? The West has so far not imposed sanctions on oil & gas companies but there have been hints from the US that this option is on the table. Likewise, there is the potential that Russia could turn off the taps. Both of these options would add considerably to the market volatility.”
"On the agricultural side, the effects of the invasion are going to impact wheat prices. Russia and Ukraine account for c.30% of global wheat exports. The EU is self-sufficient in wheat but countries further afield, especially in North Africa which has experienced drought, will be affected.
“In recent years, Russia has put a tax on wheat exports in order to increase domestic supply and limit price inflation. That has caused its exports to dip but it was Ukraine that stepped in to fill the export gap. East Ukraine, including the area around Kharkiv, is a key area for wheat production in Ukraine. We think wheat production globally is entering a multi-year period of deficit.
“In terms of other commodities, corn production is largely centred in Northern Ukraine. If wheat prices rise then corn will follow, but wheat is the more important risk.
"Ukraine is also a large producer of sunflower oil but this is relatively little used globally compared to other agricultural oils. However given the tight situation of the palm oil market in Asia, global vegetable oil prices will continue to be supported.”
Welcome back to the live blog.
Sean Markowicz, a strategist in our strategic research unit, has just published a piece - Ukraine crisis: what does it means for asset allocation?
"The risk of stagflation favours inflation-hedges such as commodities and gold," Sean says.
Our Chief Economist Keith Wade has shared his views on the economic impact in this snapshot article published here. Here are some of the key quotes:
“We think events of Thursday are taking the global economy in a more stagflationary direction.”
“We expect Europe to be the region that takes the biggest hit to both growth and inflation”
“This week’s events have reinforced our conviction that the ECB won’t raise rates this year and will continue QE.”
"I think the Federal Reserve will be more gradual now in its monetary tightening... I expect four rate rises from the Fed this year now, rather than the five I was forecasting previously."
How reliant is the world on Russian commodities exports?
Tom Wilson, Head of Emerging Market Equities
“Russia is an important exporter of oil, gas, industrial metals, precious metals, fertilisers, and soft commodities such as cereals. Russian exports in these categories often represent a significant share of global supply."
See more detailed comments from Tom Wilson on the potential impact of sanctions below.
Our Head of Strategic Research, Duncan Lamont, has dug the numbers on how the stock market usually performs during periods of heightened fear. He found that a strategy which switched out of markets whenever the Vix index, the market’s “fear gauge”, spiked would have underperformed one which remained continuously invested by 2.3% a year, since 1990. See his article here: Ukraine crisis: how does the stock market perform when the Vix fear gauge surges?
At times like this it's worth revisiting this piece from our economists from 2019: How does geopolitics impact investment returns and what can you do about it?
Fund Manager Dorian Carrell and Economist David Rees join the latest episode of the Investor Download podcast. In it they discuss the escalation in tensions between Russia and the West and what it might mean for the global economy and financial markets.
You can listen to the podcast by clicking the play button at the top of the screen or subscribe to the Investor Download wherever you get your podcasts.
February 24: Russia invades Ukraine - how did we get here and what are the market implications?
The start of 2022 has seen geopolitical risk come to the fore, as tensions between Russia and Ukraine/the West have escalated. Events have taken a sombre turn this week as hopes for a diplomatic resolution waned, and early on Thursday morning Russia launched a full-scale military invasion of Ukraine.
This crisis continues to unfold, and drawing firm conclusions on how things play out is impossible. There is major concern over the humanitarian impact, but sadly the prospects for near-term de-escalation have faded. This will have consequences for millions of people.
Taking a step back, it is clear that there will be significant ramifications globally. New information continues to filter through, and further Western sanctions are being prepared as we write. We analyse the dynamics as things currently stand, review potential scenarios, and assess the implications for markets.
What has changed?
Recognition of separatist regions, and invasion of Ukraine
In the early hours of 24 February, President Putin announced a major military operation in Ukraine. This was termed as an effort to defend the people of two separatist regions in Eastern Ukraine; Donetsk and Luhansk. However, the incursion has not only extended to these disputed territories, and Russia has launched a full-scale military invasion of Ukraine.
Russian troops have massed on its border with Ukraine in recent months. Russian forces also built-up on the Belarusian border with Ukraine, as well as in Transnistria, a Russian-backed breakaway region of Moldova. Today, together with Russian forces in Crimea and the Black Sea, these forces have launched attacks on targets across Ukraine.
The moves follow President Putin’s decision to officially recognise the independence of Donetsk and Luhansk earlier this week. These two regions have been in a state of civil war since 2014, and neither the separatists nor the Ukrainian government forces held full control of these regions. Russia indicated that it will recognise these regions in full.
Russia is and has been strongly opposed to NATO expansion in countries it sees as being within its sphere of influence. One key issue of contention has been Ukraine’s 2019 constitutional commitment to join NATO. As such, Russia has been seeking a reversal of this commitment from Ukraine, or a commitment from NATO not to admit Ukraine.
Diplomatic negotiations have so far failed, and a pathway to de-escalation looks narrow. Dropping Ukraine’s ambition for NATO membership was always politically difficult for President Zelensky, while the West was wary of heeding to the Kremlin’s demands. Given the degree of Russian aggression overnight, neither position seems likely to change at this point.
The US and other Western allies announced new sanctions on Russia in response to the recognition of the separatist regions in the east. These were relatively limited in nature, but more severe sanctions are now being drawn up, which we await the details of. The below is a summary of what was announced earlier this week:
US sanctions include measures against two Russian banks, extended restrictions on sovereign debt trading, and on a number of individuals. It has also banned US citizens from investing in, trading with, or financing the separatist regions.
EU sanctions target 351 Russian parliamentarians who voted in favour of the recognition of the breakaway regions, as well as 27 Russian individuals and entities which the bloc believes are playing a role in relation to current actions towards Ukraine.
The UK has sanctioned five Russian banks, and frozen the assets of three Russian citizens. In addition, Germany has suspended the certification process of the Nord Stream 2 natural gas pipeline, which runs between Russia and Germany.
What impact could sanctions have?
Tom Wilson, Head of Emerging Market Equities
“The Western sanctions response is expected to be robust, but it is difficult to gauge the impact until we see the full extent. There is also uncertainty regarding the Russian response to sanctions.
“Sanctions will weigh on future growth, although Russia is relatively difficult to sanction. The country is not dependent on external capital, is a net external creditor, has negative net external funding needs, disciplined fiscal policy, low government debt, and orthodox monetary policy.
“Furthermore, Russia is an important exporter of oil, gas, industrial metals, precious metals, fertilisers, and soft commodities such as cereals. Russian exports in these categories often represent a significant share of global supply.
“Sanctions which impact trade may result in higher global commodity prices, which would be stagflationary and cause economic pain. This may be particularly so for Europe, given its reliance on Russian gas.
“The threat of sanctions does not appear to have deterred Russian incursion. However, an invasion may drive a more robust and sustained Western response than expected. It may be that NATO has been given fresh purpose and that Russian action triggers a marked increase in NATO presence in Eastern Europe.”
Are there broader implications for global markets?
David Rees, Senior Emerging Markets Economist
“The key focus from a global perspective will be on the impact of higher commodity prices and the impact on inflation. This morning we have had a taster of what will happen to energy prices, but the impact on commodity prices may be broader, given Russia’s importance across the commodities complex.
“Inflation has been an important theme for investors. We have been forecasting a moderation in inflationary pressure this year, but it is likely that above-target inflation persists for longer, and indeed could tick higher in the near term. While we still see some moderation coming, more persistent inflation will hurt growth.
“When we last published global forecasts in November, we had an oil price shock scenario at around $100, but we might have to go back to the drawing board now with our new forecasts. $120 might be the new scenario, but it could rise even further, and it will have a bigger impact on growth. We need to wait and see how the dust settles on this, markets are volatile and uncertainty extremely high.”
How have global markets responded?
Russian equities, as measured by the MSCI Russia Index, were already down by over -24% in US dollar terms year-to-date, at the close on 23 February. Today has seen a severe sell-off, with the MOEX Russia Index down by over -30%, the Russian rouble down -8.5% relative to the US dollar. Russia’s 10-year government bond yield has climbed to 10.69%, its highest level since 2015. Ukraine’s currency, the hryvnia, fell more than 9% yesterday, before trading was suspended.
European equities have also moved lower today, with the Eurostoxx 600 Index falling by 3.8% and the UK’s FTSE 100 down 3.1%. In Asia, Hong Kong’s Hang Seng Index was down by over -3%. Meanwhile, Brent crude rose by around 7% to over $104 per barrel, its highest level since 2014. The US 10-year bond yield has increased to 1.93%, while the US dollar index is up 1.2% today.
What is the outlook from here?
Russia’s recognition of these breakaway regions and subsequent invasion of Ukraine curtails almost any possibility of the Minsk II agreement being implemented. This was the protocol signed back in 2015, which although it did not end the conflict, was established as the basis for a resolution.
De-escalation now looks to be even more complicated. Uncertainty has increased, and the risk of further escalation is palpable. Western sanctions are being intensified and the response from Russia will be closely watched. The risk of more prolonged uncertainty is high.
Johanna Kyrklund, Group Chief Investment Officer and Co-Head of Investment
“The one major source of uncertainty is how the Ukrainians and the Western powers will react. The assumption is that the response will be ever tougher sanctions. But there is also the question of whether at some point the West will be willing to intervene militarily.
“Looking beyond the impact of geopolitical risk on risk premiums, the main economic transmission mechanism is via energy prices. This poses particular challenges for Europe given its reliance on Russian energy.
“This has detrimental implications for growth and complicates the picture for the European Central Bank.”
Dorian Carrell, Multi-Asset Fund Manager
“The broad scale of military operations is an escalation not expected by markets. A series of steps are likely to follow. Firstly, there will be the imposition of further sanctions from the West. We would also expect Russia to react in some way, possibly with counter measures. With this in mind, and given that Russia’s ultimate military objectives are still unclear, we don’t think we are at peak uncertainty yet and further market stress could follow and volatility persist.”
Tom Wilson, Head of Emerging Market Equities
“Overnight escalation has caused severe market stress. In the near term, uncertainty will remain elevated, and as a result, the risk premium on Russian assets is likely to persist.
“We await the detail on additional Western sanctions, and the response from Russia. The situation in Ukraine is grave but we remain focused on making rational decisions, based on new information as it appears.”