The current situation in Ukraine has sent shockwaves around the world and the human impact of this conflict has been devastating for many. Here we look at the ripple effect on oil and gas and interest rates, and the outlook for markets.
Russia has been excommunicated from the global payments system SWIFT and sanctions have been imposed on the Central Bank of the Russian Federation (CBR), meaning it cannot access almost two thirds of its $643 billion reserves which are lodged outside of Russia. This has prompted the CBR to more than double interest rates to 20% and has sent the rouble plummeting to all time lows against the dollar.
Many Russian securities fell by around 90% in value before all assets became virtually untradable and removed from MSCI and FTSE indices. It was not just the direct Russian Companies that were impacted; there is a ripple effect with the likes of BP and Shell seeking to disaggregate and in time offload Russian investments, German carmakers have suspended deliveries and operations, and shipping to and from Russia has been restricted to foods and medicines.
The impact on the Russian economy will be severe and outsized when compared to the initial fallout for the wider global economy with Russia accounting for just 1.8% of global GDP. The ‘but’ sits around energy supply. Russia is a key supplier of oil and gas to the world, with geography meaning that much of this is focused on Europe. Fear of supply or potential changes to sanctions have prompted the oil price to move above $110 a barrel after OPEC opted not to ramp up production levels beyond existing plans. In such uncertain times it seems reasonable to expect the oil price to be much more volatile than has been the case for the past 10 years and all eyes will be on the $140 level reached in 2008 which many will see as significant. Oil has been the universal driver for inflation in a range of economies not least the UK so further moves higher will only increase pressure on Central Banks.
So intense has the news flow been on Ukraine and Russia, many market participants have almost forgotten about the potential increases of interest rates. The Federal Reserve appear focused on a tightening cycle with Jay Powell throwing his weight behind a 25bps hike this month and more to follow in an effort to keep inflation within a manageable range. That said, should anxiety surrounding Ukraine move beyond geopolitical and humanitarian concern and begin to impact the global economic recovery, might we see a degree of temperance in terms of the timing and size of those interest rate moves? For now, consensus would point to anywhere between four and six interest rate rises in both the UK and US this year and investors will be monitoring central banker announcements for any hints as to a shift in approach. Common sense would suggest there will be fewer interest rate increases or that Central Banks will be mindful of the political concerns and may push out the timetable. After all, Central Banks have a role to promote financial stability, which feels like a topic that should be taking up more of their thought process.
Clearly, the fast moving and volatile situation in Eastern Europe is extremely concerning, however, it is worth bearing in mind that from an investment perspective steep declines in stock markets are not unusual, and they tend to be short lived.
History shows us that equities have been resilient during periods of crisis in the past, such as the Cuban Missile Crisis, the Iraqi invasion of Kuwait, and 9/11. The impact of these events on the markets, and indeed the economy, were much more fleeting than their significance in modern history.
Stock markets tend to look forward and may start to anticipate less fear and stability in sentiment before it might be obvious in the white heat of news flow. So, while stock markets are likely to remain volatile in the short term, this may be more to do with ongoing concerns about inflation and interest rates. The longer-term outlook for the global economy and equities remains positive as the pandemic-related headwinds reduce, with job and wage gains becoming more common and company balance sheets robust enough to see through a challenging period.
Written and prepared for Crowe Financial Planning UK Limited by John Moore (Senior Investment Manager at Brewin Dolphin).