Risk-off moves intensify as Russia invades Ukraine

[MongiIG]

Russia’s invasion of Ukraine has sparked further volatility, hitting markets that were already under pressure due to higher inflation and rising interest rates.

Source: Bloomberg

 Chris Beauchamp | Chief Market Analyst, London | Publication date: Thursday 24 February 2022 

Ukraine invasion adds to market woes

For markets that were already grappling with a world of higher inflation and rising interest rates, the invasion of Ukraine comes as an additional shock.

Now, as well as thinking about how inflation will hit earnings and interest rates may affect economic growth, investors must consider how the breakdown in relations between Russia and the West, along with the imposition of sanctions, will affect the global economy. We are in uncharted territory, or at least experiencing something that has been quite rare in recent decades.

Next steps unpredictable

Wars are by their very nature unpredictable. The Russian intervention is on a scale not seen for a long time, but if it turns into a long occupation then the situation could persist for an extended period. Western sanctions will likely draw a Russian response, and with the Nord Stream 2 pipeline now off the cards European consumers face higher prices for their energy.

The broader geopolitical situation is likely to remain uncertain too. How long will the Russians stay in Ukraine? And will Putin follow up this move with more aggressive actions against the Baltic states? Europe and the US may also have to increase defence spending to meet the Russian threat, reducing the funds available for other activities.

How will this affect central banks?

Central banks as well will have to consider how the situation affects their plans to slowly raise rates. Rising oil and gas prices will drive inflation yet higher, and combined with the shock of the invasion a downturn in growth seems likely, potentially even leading to a recession in developed economies. Will the Federal Reserve, European Central Bank and others have to think about moderating their plans to raise rates, or even slow down their reduction of the size of the asset purchase programmes. Perhaps they may even look at keeping quantitative easing in place, to try and offset the shock to their economies.

For the time being we should expect more volatility across all asset classes. Equities look set for additional falls, although some stocks will rise thanks to higher commodity prices. But in other cases investors will expect earnings to fall, putting pressure on valuations. In the face of such uncertainty, the risk-off moves seem likely to continue.