We are now more than a week into Russia’s invasion of Ukraine and the escalation of sanctions against the belligerent country occurred faster than some predicted. This was the sixth straight week of weakness and the terrifying headlines of Ukraine surely are reasons for apprehension. Russia’s military appears to be having significant logistical problems. This mixed with a stolid and inspiring Ukrainian resistance has meant that Putin’s progress has been much slower, and costlier than many military analysts expected. We pointed out some of the issues that have emerged with his campaign earlier than most in our Signal From Noise last week. The southern town of Kherson fell, which is the first major urban center to fall. Kharkiv and Kyiv are still holding out, and Mauripol seems in trouble. Russian progress has been most quick on the Southern portion of the country. Markets have had a tough week but are up significantly from their February lows. The glass may be more half-full than you think.
However, as we’ve stated the way markets process these events is often markedly different than the way we experience them. Despite the choppiness and down-days over the week Mark Newton, Our Head of Technical Strategy has actually been positively surprised at how well the market has held up. He sees a breach to the downside of 4,279 as likely portending a re-test of February lows while a move past 4,417 should lead to a further move up.
The US equity market has been relatively outperforming Europe for the obvious reason of geographic proximity to the instability. Some US firms like Black-Rock and others who are in the ETF business have been reporting difficulty in liquidating any Russian assets given the unprecedented sanctions and also restrictions from Russian officials. However, it is thought that the risk for financial contagion in the United States from sanctions fall-out should be relatively low. The commodity impact from the raging conflict in Ukraine could potentially be the largest interruption of commoditiesin history. Wheat futures had their largest weekly rise since the 1950s and Russia and Ukraine together account for nearly a third of global wheat exports. Whether the conflict is a sustained affair or if it is resolved over the shorter term will have a great bearing on what the scale of the impact will be.
US officials said on Friday that they believe the US economy is strong enough to weather a ban on the import of Russian oil. Russia produces about 12% of the world’s total supply of oil. The Whtie House pointed out, that given existing supply chains, the US doesn’t import very much Russian oil in the first place. There was some alleviation of pressure on oil prices on Thursday as a deal with Iran was rumored. According to some diplomats, a nuclear deal with Iran is days away. However, Thursday to Friday saw the biggest overnight increase in prices at the pump since Hurricane Katrina in 2005. Gas prices have surged to their highest levels since 2012 at $3.84 a gallon for regular. President Biden addressed this issue in his State of the Union address and released more money from the Strategic Petroleum Reserve. There are nine states where gas is over $4 a gallon including New York, California, Illinois, and Pennsylvania.
There was a particular alarm on Thursday night when Russian soldiers were shelling Europe’s largest nuclear power plant. Ukraine was the location and epicenter of the Chernobyl nuclear disaster in the late 1980s, so this event is particularly impactful for them. The United Nations condemned the action on Friday. It appears that the very last carve-out from sanctions for Russian Energy is collapsing as their aggression, civilian casualties and recklessness seems to only intensify. Russian opposition to the war seems to be building as well, but this may be mitigated by a new law passed that basically assigns a 15-year prison sentence to report any alternative narratives to the war than those farcical ones approved by Putin’s increasingly isolated regime.
Markets got some relief due to Jay Powell’s testimony before the House and Senate. He pretty much removed speculation of a 50 bps hike and said the committee would have to be “nimble” in response to the chaotic situation in Ukraine. While there was a definite dedication detected to continue fighting inflationary pressure, Powell’s comments were still incrementally more dovish than what the Fed Funds future has been pricing in a few weeks ago. Some Fed officials have also said that the Ukraine War likely will only further the need for hawkish action from the Fed as it could be a major source of additional economic pressure.
Economists appear to be revising their inflation expectations upward for March. Russia is a particularly important producer of many commodities from Wheat and Energy to precious metals vital in many industrial supply lines like Palladium and Nickel. As Western Governments prepare to remove the last hold-out in their economic warfare tool chest, the inflationary effect of particularly the rising price of oil could cause inflation to peak later than it would have. Oil prices are particularly impactful for overall inflation because they touch vital aspects of the economy like transportation, manufacturing, power generation, chemicals, and materials. According to JP Morgan’s Chief Economist, Bruce Kasman, the rough way to think about the price impact from rising oil prices is that for every 10% increase in the price you could remove about .2% from global growth expectations and add about .3% to CPI. Kasman was one of many economists to raise his inflation forecast since the war broke out. The impact of metals and grains is harder to measure because of the complexity of supply lines. Natural gas getting cut off from Europe is of course a potentially huge impact. Dutch and British natural gas futures are up 1,000% in the past year compared to less than a tenth of that in the United States. Investors have sought safety in bonds and Treasury yields dropped. The spread between the 2-yr and 10-yr hit its lowest level since March 2020 on Friday as concerns ostensibly rise about inflation sapping growth.