Russia and Vladimir Putin’s decision to invade the Ukraine has dominated the news. More than anything, we hope for a speedy resolution for the sake of the Ukrainian and Russian people. The lead-up to and the invasion of the Ukraine unsettled financial markets contributing to an initial decline before a furious rally ensued.
The financial implications of this unfortunate invasion are wide-ranging. Here is a list of a few of the ramifications resulting from the Russian invasion:
- Higher Energy Costs – Russia produces a little more than ten million barrels of oil a day which amounts to approximately ten percent of global energy supply. Any disruption to supply should lead to higher oil and gas prices.
- Supply Chain & Inflation Risks – Russia is not an economic power. The World Bank estimated Russia’s 2020 GDP at a little less than $1.5 trillion, or slightly less than two percent of global GDP. It is the eleventh biggest economy as measured by the World Bank. As a reference point, Italy, Canada, and South Korea had larger economies, while Brazil’s GDP is slightly lower than Russia’s. Nevertheless, Russia and the Ukraine are significant exporters of certain grains and metals. Any decrease in their production levels could lead to higher global food prices while impacting the supply of key metals used in numerous products.
- Elevated Cyber Risks – Russia has been waging cyber war against the Ukraine. The risks are not limited to the Ukraine. Cyber-attacks can spread from their initial point-of-attack as the intended victims and other national and independent hackers use the code for their own purposes. Moreover, an extended conflict could lead the Russians, or hackers aligned with Russia to launch attacks against U.S. and Western interests.
- Fixed-Income Implications – All things being equal, risk-off environments lead to a flight-to-safety. We have seen that happen as Treasuries and gold have held up relatively well during the recent turmoil. Treasury yields could rise in a risk-off environment if inflationary pressures build as a result. If the crisis leads to risk-off behavior and higher commodity prices, a drop in economic activity could lead to lower Treasury yields. If the Federal Reserve and other Central Banks were to pause their rate-hiking plans, this could lead to lower yields and borrowing costs moving forward.
- Stock Market Implications – The market was experiencing a correction before the Russian invasion. The invasion increased market volatility which is unlikely to abate much until the war is over. Investors should expect more sessions with large moves and intra-day swings. This is not all due to Russia. The original source of market volatility in 2022 was the expectations of tightening global monetary policy. The situation in the Ukraine exacerbated risks, but it did not eliminate the need to tighten. Markets usually remain volatile into the first rate hike. There are some good values out there. The valuation of the S&P 500 has improved significantly with the S&P 500 now trading at less than twenty times 2022 estimated earnings according to Bloomberg. Stock markets are likely to be higher twelve months from now. However, NPP expects the volatility to continue in the immediate future.
To sum up, this war likely worsens the high inflation trends that were already in place around the world. Coming on top of two years of COVID-19 related disruptions both in the economy and lives of the average person, this is an especially difficult time for consumers. A quick resolution to the war would ease inflationary pressures, but we will still be a long way from an environment of low inflation and normal supply chains. We believe financial markets will remain volatile until we see a clearer resolution of these issues.