Ukraine conflict: how will it impact markets?

It goes without saying that the terrible events in Ukraine over the past week have changed the trajectory of the world. Russia is now a pariah. Their actions have been roundly rejected by NATO members and allies.

Russia’s access to the global trading system is now massively restricted. As a result, Russia’s central bank increased interest rates from 9.5% to 20%(!), and the Ruble (USDRUB) devalued from 84 to 110 over the weekend, losing approximately 30% of it’s value at one point.

These sanctions will not come without costs for the West however. As the world adapts, there will be winners and losers, and the many ripple effects might not be so obvious just yet.

Let’s take a look at some market moves and drivers:

First up, commodities:

Oil (Brent)

Oil’s momentous rise hasn’t escaped attention… In the past two years, the Oil price has gone from practically zero in the turmoil at the start of the pandemic, to over $100 per barrel. It’s worth noting that Russian Oil is now trading at a discount to the spot market, even though Western sanctions have tried not to directly target Russian energy companies. Europe is especially dependent on Russian Oil and gas and it’s not easy to replace it from elsewhere.

OPEC+ look set to continue their alliance without changing the cartel’s plan to gradually return supply to the market, but even as they increase the supply quotas, many OPEC+ members are struggling to meet them.

US shale producers could be tempted into a comeback under the circumstances, but this will not happen overnight. Goldman Sachs analysts argue that the disruption could drive Oil to $115/barrel within the next month.

OPEC+ meets this week. The group is widely expected to maintain the policy of returning 400,000bpd production each month.

Natural Gas

As mentioned, Europe (and especially Germany) is very dependent on Russian gas. We’ve already had a trial run this winter. Think tank Bruegel says that the EU could survive without Russian gas next winter, but that would be based on the assumption that Gazprom continues to meet long-term contractual obligations.

There’s a delicate balance here too. Whilst the EU could refill their storage tanks with expensive liquefied US gas, there’s always a risk that Gazprom floods the market with cheap gas to compete (or make ends meet…?)

Keep an eye on US Natural Gas. Europe’s demand could leave the US short at home…

Grains We covered the underlying issues with agricultural production (Is your food about to get more expensive?) back in December, focusing specifically on the potential impact on Wheat.

According to the USDA, Russia & Ukraine’s share of global wheat exports is approximately 30%, and 20% of corn exports. Continued conflict is bound to impact agricultural food production.

On Monday, Chicago corn futures rose by the exchange limit $35 to $690.75/bu.

Gold: The Geopolitical Safe Haven?

Always one to watch at times of strain and tension. Whilst it’s easy for gold bugs to say that gold is a safe haven and something everyone should own for just such an event as this, the times of underperformance don’t always justify the stance.

Plus, there’s a double-edged sword. At times of stress, forced selling can occur. Sometimes it’s a central bank of a smaller country in need of reserves, or funding stress in other areas of the market can force sales of gold to meet margin.

Either way, gold is likely to be in the spotlight in the coming weeks.

Defence Stocks Something that’s easily forgotten is how military spending is intended as a deterrent to actual war, rather than to profit from or prepare for war itself. Similar to the nuclear principle of Mutually Assured Destruction (MAD), but less catastrophic.

Germany suddenly woke up to this, and after years of military under-spending, has made a complete 180 in the face of Russian aggression. Chancellor Scholz announced that Germany will raise defence spending to at least 2% of GDP, add this policy to the German constitution, and initiate an immediate EUR100bn defence fund!

Other NATO members may follow suit.

Reuters report that Germany could purchase U.S. F-35 fighter jets built by Lockheed Martin to replace its ageing Tornado in the role of nuclear sharing, Scholz said.

But the next generation of fighter jets and tanks must be built in Europe jointly with European partners, particularly with France, he said.

Among European names Thales, Rheinmetall & Leonardo were the standout performers.

US defence stocks also got a boost, with Lockheed Martin & Northrop Grumman both posting solid gains early in the session, although notably smaller moves than their European counterparts.

There will be other effects too…
Especially in Europe. Lots of focus on the banking sector after Monday’s performance. Societe Generale shares fell by nearly 11% on Monday.

And there’s two real themes or schools of thought to monitor here. One is the obvious solvency risks created by removing Russia’s banks and many businesses from the European banking system. The ECB has already wanted that the European arms of Russia’s Sberbank would likely face insolvency. All banks with Russian ties are being closely monitored by ECB supervisors.

The other, less obvious problem is that the eurozone economy faces rising stagflationary risks. This is the absolute worst of both worlds. Low economic growth and high inflation increases slowdown/recession risks, weighs on consumption, potentially increases unemployment and generally isn’t a good thing for any economy!

It also means that the ECB is less likely to hike interest rates. Which isn’t ideal for banks. Higher interest rates are normally a big positive catalyst, as higher rates increase lending profitability and returns on reserves. It’s often been said that low rates are a key reason for the low profitability of European banks relative to their US peers.

Recent economic positivity was expected to see the ECB finally break those low-rate shackles, but the economic sanctions and fallout throw all of that into doubt.

After this weekend, it’s not the only thing that’s changed…

Not investment advice. Past performance does not guarantee or predict future performance.