The experience of Russia’s annexation of Crimea shows that the impact on global asset prices might be limited. However, every war conflict is unique and making predictions becomes very difficult in this environment. For reference, between the end of January 2014 and the beginning of February 2014, the S&P 500 suffered a 5.6% drop that was reversed in mid-March of that year (Crimea was annexed on March 18). The different regional stock indices were under pressure during the first quarter of 2014 while the conflict lasted, but then ended up recovering their initial levels towards the end of the second quarter of that year. The rate spread between emerging markets and the US Treasury —as measured by the JP Morgan EMBI index— rose from 327 points in January 2014 to 396 points on February 3, before returning to the initial level towards end of March.
What should we expect in terms of the prices of financial assets
Due to the heightened uncertainty, pressure on equity markets is likely to remain high, particularly in European equities more than in the US due to the former’s dependence on natural gas from Russia, while in emerging markets the increase in the risk premium might bring pressure in the short term, particularly in Russia and in Eastern European countries due to their geographical proximity to the conflict. On the interest rate side, higher commodity prices will continue to generate inflationary pressures and greater anxieties regarding the dynamics of monetary policy in the US. On the other hand, greater uncertainty regarding the potential impact on global activity and the refuge towards quality assets may end up benefiting US treasury bonds, so the final result is not entirely clear. In emerging market bonds, increased risk aversion, materialized through a higher interest rate spread, should lead to negative returns in dollar fixed income. However, for the latter, the dominant factor will be the monetary policy in the US and the risks to the growth dynamics in emerging countries.
With regard to commodities, Russia has a determining role in the energy markets with an oil production of 10.5 million barrels per day (OPEC production in January was 28.1 million barrels per day) and produces 10% of the world wheat (Ukraine 4%). This suggests that the pressure on energy commodities, such as oil and natural gas, should continue in the short term, while in grains the geopolitical conflict adds to the effects of La Niña in South America. It is worth noting that the 16.2% return in raw materials so far this year is mainly due to energy commodities (+27.5%) and grains (+19.8%).
Looking beyond geopolitical conflict: The Federal Reserve
While high volatility is expected from geopolitical events in Ukraine, monetary policy in the US will have more lasting effects on asset prices. On March 16, the Federal Reserve is expected to begin its monetary policy rate adjustment cycle, for which the market is expecting six hikes of 25 bps in 2022 and 2 in 2023. Additionally, the Federal Reserve will most likely provide guidance regarding the drawdown on its balance sheet, which represents 38.2% of the GDP of the United States (as a reference, towards the end of 2009 it represented 15.3%). The conflict in Ukraine may slow down the speed of monetary policy tightening in the US, but with inflation at 7.5% – the highest level since 1982 – and the prospect of further pressure from the commodity market, the pace Federal Reserve tightening will become a more dominant and enduring factor in asset prices in the coming months.
Wealth Management Research – Balanz Capital
