The war’s effect on the global economy and markets
Only a couple of months ago, investors were hoping for an end to the pandemic. Now, the headlines are dominated by the Russian-Ukrainian war.
After months of amassing troops near the Ukrainian border, Russian president, Vladimir Putin finally declared “a military operation” on February 24.
In the following weeks, Europe has seen its worst war since Second World War. More than 2 million Ukrainian refugees fled the country within two weeks.
Tensions rose last year between Russia and Ukraine due to the latter’s desire to join the North Atlantic Treaty Organisation (Nato), which Russia views as a security threat.
Since the former Soviet Union broke apart after the Cold War – Nato, the US-led military alliance – has quickly expanded to the East.
In response, Moscow demanded that Ukraine not join Nato, and insisted Nato forces return to where they were stationed in 1997.
Since the invasion, Western countries have imposed a series of economic sanctions hoping to limit the Kremlin’s ability to finance its war.
The US Treasury Department immobilised Russian Central bank assets that are held in the US, and imposed sanctions on the Russian Direct Investment Fund, a major sovereign wealth fund.
Financial institutions outside the US which hold dollars for the Russian central bank cannot move them.
As a result, Russia cannot access the $630 billion forex reserves it has built over years, to support its currency.
The Rouble depreciated 45 per cent within two weeks. After a sharp sell-off, the Russian stock market has halted trading February 25th.
A number of countries planned to remove selected Russian banks from SWIFT, a global financial artery which allows rapid transfer of funds across borders.
This action will make international transactions increasingly difficult.
On March 8, US president Joe Biden announced a ban on all Russian fossil fuels imports, including oil and gas.
The UK joined with a ban on Russian oil imports, though did not ban natural gas and coal.
With a quarter of the European Union (EU)’s oil imports coming from Russia, along with 40 per cent of its gas, the EU will not join in banning these energy imports.
Nonetheless, the EU announced its plan to cut dependence on Russian gas by almost 80 per cent this year. The Nord Stream 2 natural gas pipeline, which was designed to deliver gas from Russia to Germany, has been suspended.
Russia is the second largest oil exporter in the world and its war with Ukraine has shot crude oil prices past $120, the second highest in history.
The American Automobile Association said average US regular grade gasoline price hit $4.009 per gallon last week, up 45 per cent from a year ago, adding more upward pressure to already hot inflation.
As a net oil exporter, the US has the capacity to increase oil output, but it will take drillers some time to expand enough production to make up for the shortfall.
More than 100 companies have pulled out of Russia in an effort to boycott its invasion.
Multinational companies from financial, entertainment, retail, shipping to autos have stopped their business in the country.
Among the companies are Apple, Netflix, Disney, Mastercard, Visa, American Express, Ikea, etc. Even though Russian economy will be in deep recession this year, economic pressure likely won’t be enough to force Putin to retreat.
Given Putin’s risk seeking character, Russia’s oppressive leader could act even more aggressively, especially given his better-equipped military forces and penchant for “winning” at all costs.
Fortunately for investors, the Russian economy only makes up 1.7 per cent of global GDP and therefore global growth may be dented only modestly.
However, the immediate impact is more severe in its smaller emerging market trade partners.
To name a few, Turkey, Egypt, Vietnam and the Philippines are vulnerable to higher import costs and lower exports.
On the other hand, net oil exporters such as Saudi Arabia or Brazil will benefit from higher energy prices.
The European economy will likely suffer a significant slowdown because of higher energy prices. However, we are now exiting the winter season when demand for gas heating is steadily becoming less critical.
In 2021, Russia was the fifth largest partner for EU exports of goods at 4.1 per cent and the third largest partner for EU imports of goods at 7.5 per cent.
The direct impact on US companies’ earnings should be limited, but the indirect impact resulting from higher inflation will be more pronounced.
For example, Russia and Ukraine combined export 29 per cent of global wheat supply.
With sanctions on Russia and closing of Ukraine’s ports and factories, wheat prices have risen by 67 per cent so far this year.
The surge in wheat price affects many food items from cereal to cooking oils, as well as meat prices since grains are used to feed livestock.
The pandemic-triggered supply chain bottleneck has now been worsened by the geopolitical uncertainty.
Ukraine produces around 70 per cent of global neon gas, which is critical in the semiconductor industry.
With Russia closing its air space to 36 nations, air freight will get more expensive as planes must take longer alternative routes.
Russia produced 17 per cent of world’s high-grade nickel, which is used to produce electrical vehicle battery.
Fear of supply shortage pushed nickel price to more than double in a single day, triggered by a short squeeze.
On the plus side, geopolitical tension adds resistance to the US growth rebound and should thereby temper the central bank’s hawkishness.
During Fed chairman Jerome Powell’s testimony before Congress on March 1, he stated his preference for a 25 basis point rate hike for the March 16 FOMC meeting, unless inflation gets much higher. Earlier forecasts included a Fed rake hike of 50 basis points.
For investors with longer term time horizons, market sell-offs such as this one, have historically presented opportunities to buy high quality companies at lower prices.
In this environment, we continue to focus mainly on the US market which is more removed from the direct war impacts, while staying cautious on Europe and most emerging markets.
Even though the likelihood of Nato joining the war is minimal, significant financial ties between Europe and Russia could have more severe economic impact in the region.
Nan Wang, CFA is a Portfolio Manager at LOM Asset Management Limited in Bermuda. Please contact LOM at 441-292-5000 for further information. This communication is for information purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, investment product or service. Readers should consult with their Brokers if such information and or opinions would be in their best interest when making investment decisions. LOM is licensed to conduct investment business by the Bermuda Monetary Authority.