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We have been listening to a great many experts in the military, geopolitical and investment arenas over the last week, considering the impact, both short term and long term, of Russia’s invasion of Ukraine. The escalation of political tensions into military conflict caused increased volatility in global stock markets and sent the price of oil above $110 a barrel for the first time in seven years.
As financial planners and investment managers, I will keep my comments focussed today on the potential implications for global energy supplies, the path of inflation and monetary policy, along with the impact of sanctions imposed. While undoubtedly some Russian assets are outside the reach of sanctions, more than half are held in NATO countries - and as such, Russia cannot use them to shore up its currency and as a result we have witnessed a massive depreciation of the rouble.
Russian banks are also having to endure restricted access to the international payments system SWIFT. This has created a sense of panic over its ability to shift money in and out of the country. Russia’s central bank can of course continue to print money, but this will only exacerbate the problem by fuelling additional inflationary pressure. Crucially, however, the international community has allowed Russia some wriggle room by not completely cutting it off from SWIFT, as it wants Russia to be incentivised to sell oil and gas to the rest of the world, and especially Europe, because it will be in dire need of hard currency. Russia is neither a big economy nor major player in international trade. What is more significant are oil and gas imports, given Europe’s dependence. We have already seen significant increases in wholesale gas prices, which is hitting Europe’s purchasing power.
If the crisis continues and oil hits US$125 a barrel and gas €125 per megawatt hour, the impact on Eurozone GDP growth could be quite significant, perhaps knocking one percentage point off GDP growth this year and next. Notably this would be a significant growth shock to Europe, but not to the rest of the world, where the impact would be far less severe.
Whilst developed central banks may well, for now, talk down aggressive rate rises (The US Federal Reserve this week changed market expectations from a 0.5% rate rise in March to a 0.25% rate rise), there are further inflationary forces at work here that may force their hands later in the year. These include higher energy prices, particularly in mainland Europe. We now expect to see more spending on defence, as well as cybersecurity and less dependence on Russian gas. Longer term, a major focus in Europe on energy security will likely manifest itself in both the development of liquefied natural gas capacity to reduce dependence on Russian gas and an acceleration of the shift to lower carbon solutions, with a particular emphasis on accelerating the economics of energy storage.
Looking at the military events of the past 50 years – and while past performance should never be seen as a guide to future returns – what we can see is that it was better not to trade on those days when crisis broke out. The Iraq invasion of Kuwait in 1990 was one of the worst but the market had rebounded within four months. This crisis has occurred just as the global economy has once again started to accelerate post-COVID-19.
As always, it is vital to keep calm and look through the crisis, as past military events tell us it is potentially wiser to keep our longer-term investment convictions. But while this lack of transparency makes life difficult for investors, it is vital to avoid panic and see how things unfold. Away from markets, our thoughts remain with those involved in this conflict in the Ukraine.