Attention now shifts to the expected impacts of the attack on energy, global growth, inflation and central bank actions.
Markets reacted strongly last week to news of Russia’s invasion of Ukraine. The world has been watching the escalation of tensions in the region since the beginning of the year. Russia opposes the idea of Ukraine joining NATO, a move it says encroaches on its sphere of influence and puts the United States on its doorstep. The invasion is likely to have a significant human cost, and our thoughts are certainly with the people of Ukraine.
Prior to Russia’s action, investors were primarily focused on high inflation and impending interest rate hikes. Now the focus is on the expected impacts of the attack on energy, global growth, inflation and central bank actions.
Energy: need to clarify additional penalties
Simmering tensions between Russia and Ukraine have driven up oil prices since the start of the year. Given the fragile demand and supply dynamics, volatility in energy prices could continue, particularly if sanctions against Russia escalate and provoke a further reaction from Russia. The United States and Europe are both trying to penalize Russia – but without hurting energy markets and creating new inflationary pressures. Russia supplies a huge amount of natural gas to Europe, and this gas cannot be replaced quickly.
Greater vulnerability to growth and inflation in Europe
The United States and Europe were already under pressure from high inflation due to a combination of supply issues and strong demand. But inflation and growth in Europe are more vulnerable to an energy price shock because, compared to the United States, the region’s economies are heavily focused on manufacturing and trade. In the United States, the economy is more diversified and service-oriented, making it less susceptible to energy price shocks, while the share of international trade in GDP is 23% (in comparison, it is 81% in Germany).
The Fed is unlikely to change course on monetary policy tightening
For central banks, geopolitical tensions make the timing and magnitude of rate hikes complex. The strategy of the European Central Bank (ECB) could be affected more directly if the crisis escalates (and we could see it delay its plans to withdraw monetary accommodation later this year). In the US, the Fed is unlikely to change course on monetary policy tightening and we continue to expect an initial 25 basis point rate hike in March.
The Fed will expect slower inflation and wage growth in the second half of 2022 to know whether to speed up or slow down monetary tightening. Oil prices are unlikely to play a major role in this decision unless a change were to have a significant impact on the outlook for economic growth.
Market response
We are seeing a sense of risk loss in emerging markets as the possibility of imposed sanctions increases, although Russia and Ukraine together make up only around 3.5% of the EM debt index in foreign currencies. strong. From a credit perspective, the investment grade and high yield markets seem to sell first and ask questions later. Most Russian companies are at the lower end of the Investment Grade rating scale and could be downgraded to High Yield due to sanctions risks.
Now is not the time to panic
Market corrections caused by wars and oil market disruptions have always been sharp but short-lived. As always, volatility prompts investors to do something urgently, but we recommend staying invested and focusing on long-term goals. Active management can help investors ride out short-term market shocks while capitalizing on longer-term trends.
Although recent events have created a difficult period for the markets, it is important to remember that volatility can provide opportunities to identify valuation gaps, unearth hidden gems or supplement existing positions at opportune times.