The focus for investors last week was squarely on the desperate events in Ukraine and broader impact on the global economy. Commodity prices soared and investors were in “risk-off” mode, particularly in Europe, as fears of a stagflation environment came to the fore. European equities bore the brunt of selling pressure, whilst in contrast both US and Asian markets held up reasonably well. On the week, the MSCI World Index was down 2.8%, the STOXX Europe 600 down 7%, the S&P 500 Index down1.3% and the MSCI Asia Pacific Index down 1.5%.1
Investor Sentiment Bearish as Ukraine Crisis Escalates
With the war in Ukraine continuing to escalate through last week, we saw sentiment turning increasingly negative amid soaring commodity prices, tougher sanctions on Russia, and a growing number of companies pulling out of Russia. Last Friday alone saw some aggressive moves lower for European markets after the Russians attacked a nuclear power plant, with the STOXX Europe 600 Index slumping to close down 3.5% on the day. Weekly fund flow data reflected the shift out of European equities with Europe seeing its largest outflows on record.
Looking at other asset classes, the flight to safety was clear, as last Tuesday saw the German bund yield having its biggest ever one-day drop on Tuesday, to end the week down about 30 basis points (bps)2 and back in negative territory. The UK 10-year yield tightened by 31 bps on Tuesday, its biggest daily drop since 1992. European credit markets show sign of stress too, with the ITRAXX XOVER CDS Index widening to levels last seen in 2020, so there will be a focus on companies with weak balance sheets.
European sector performance on the week was remarkable, with a wide spread between the best (miners) and worst (automobiles, banks) performers. Again, this was reflected in last week’s flow data, with largest-ever inflows into materials and largest-ever outflows from financials.
Commodities: Soaring commodity prices and the commensurate inflationary impact is alarming investors. The fear is that European consumer confidence and spending will be hit, and we find ourselves in a stagflation environment, with stagnating economic growth (or recession) and soaring inflation. Furthermore, central banks are already on the back foot after post COVID-19 inflation failed to prove transitory, so their options are more limited in terms of cushioning economies from a commodity shock.
To put the commodity moves in context, the Bloomberg Commodity Index was up 13% last week, the biggest-ever weekly gain.3 In addition to this, commodities overall have had the strongest start to the year since 1915.4
With Europe being dependent upon imports for about 40% of its gas, European gas has been at an all-time high and soared more than 30% at the start to this week’s trading on fears Russia could turn off its gas supply to Europe.
Crude oil prices have also surged once again as it is reported the United States is looking to find alternative oil sources to Russia. Venezuela is reportedly even being considered as a potential alternative.
For context, Russia produces 11 million barrels of oil a day, making it the world’s third-largest producer behind the United States and Saudi Arabia. The country exports between 5-6 million barrels per day of crude oil, with about half of that destined for Europe, and another 1.6 million barrels is shipped to China.
As mentioned in our last week’s Notes from the Trading Desk, it is important to remember this is not just an energy crisis. Ukraine and Russia produce a number of key commodities, and the disruption caused by this crisis can see a number of costs rising. The price of wheat rose 38% in the past week alone, and the UN Food Price Index was up 3.9% month-on-month in February and up 20.7% year-on-year.5 The fertiliser market is also significantly impacted, as Russia and Ukraine produce key components, and the chip shortage globally has been well documented in recent years. It is also worth noting Ukraine supplies around 50% of the world’s neon, a key component of chip production.6
Sanctions: In addition to the impact of these cost increases, we are also yet to see the full impact of untangling much of the Russian economy from the global economy. Governments and companies from all over the world have increased the intensity of their sanctions against Russia in a coordinated effort. For example, several Russian banks are to be excluded from SWIFT. The immediate disruption for the Russian economy is clear, with the Russian central bank hiking interest rate to 20% from 9.5%, the Moscow Stock Exchange suspending trading since last Monday and the ruble trading down about 45% last week. Many suggest the wider ripple effects from this war are still to be fully understood.
What next? Although hard to see at this stage, any meaningful improvement in the narrative between Russia and the West over the war in the Ukraine could prompt a squeeze higher in the equity market (given how extreme the moves lower have been). Focus is on the central banks too, particularly the European Central Bank (ECB) meeting on Thursday. The hope is that the ECB will step in to ensure liquidity is providing some support, particularly with credit markets under some stress. ECB Chief Economist Philip Lane stated last week the ECB will consider new policy instruments if needed and stands ready to take whatever action is needed. Despite the February EZ Consumer Price Index (CPI) coming in at 5.8%, it is expected the central bank will delay a decision on ending its asset purchasing programme. Commentary from that meeting will be important for European market sentiment.
In addition, any positive news on commodity prices would be significant. For example, if the United States can secure extra capacity elsewhere to offset disruption to Russian supply.
Looker further ahead, the next coupon due on Russian sovereign debt is due on March 16—it will be important to see if Russia defaults or make that payment.
The Week in Review
US stocks closed last week lower, but significantly outperformed their European peers. The S&P 500 and the Dow Jones indices both closed the week down 1.3%, whilst the Nasdaq Index closed down 2.5%. US companies are much less exposed to Russian energy, supply chains and consumers; therefore, the risk-off moves in the United States were relatively well-contained.
Federal Reserve (Fed) Chair Jerome Powell’s testimony to the House and Senate last week offered investors another focus away from events in Ukraine. The market had dropped its expectation for a 50 bps hike in March the day prior to his first testimony. In his testimony, Powell all but confirmed he would be supporting a 25 bps hike in March, which saw a sharp repricing of rate-hike expectations. The market now prices in a 96% chance of a 25 bps rate hike at the March meeting. Powell said that events in Ukraine had caused uncertainty, making a 50 bps hike in March unlikely. This development offered the market some relief mid-week as investors welcomed a more gradual adjustment to rates. However, Powell did not rule out larger adjustments to rates at a later date.
The February employment report offered investors another focus stateside. Nonfarm payrolls came in ahead of expectations, at 678,000. Whilst the payroll report was an upside surprise, the average hourly earnings was a miss, rising 5.1% year-on-year. With interest rates about to increase and global inflation showing no signs of abating, stagnant earnings will add to the squeeze for consumers.
Last week was mixed for Asian equities, but overall, a lot better than Europe.
It is notable that although COVID-19 is no longer a main talking point for European investors, it is still a key catalyst in Asian markets. Hong Kong led the way lower in Asia, down 3.8% last week amid reports that the government was planning to enforce a lockdown to ensure a mandatory COVID-19 testing drive planned for this month. Officials are aiming to test the whole city three times over nine days, with a stay-at-home order in place.
Japan closed last week 1.8% lower, as the government announced a raft of sanctions against Russia, including SWIFT exclusion for some Russian banks and freezing the assets of oligarchs. It also announced a range of actions to support those affected by the surge in oil prices.
In China, the Shanghai Composite also closed down as the market digested somewhat disappointing economic news. The dual meetings of the NPC and the CPPCC have seen a target of 5.5% set for Chinese gross domestic product (GDP) for this year, the lowest in more than 30 years, and the Ukraine-Russia conflict dampened sentiment.
The end of last week saw markets trade off across the region, following overnight reports of Russia’s attack on the Ukraine’s Zaporizhzhia nuclear plant. Although it was later clarified that no nuclear reactors had been hit, Asian markets failed to recover.
Looking forward to this week, we have quite a busy week economically, with purchasing managers index (PMI) data, inflation, a central bank meeting in Australia, and GDP reports lined up. In Hong Kong, the population continues to brace for a lockdown as COVID-19 cases continue to soar.
The Week Ahead
Aside from the obvious headline risk from events in Ukraine, the ECB meeting on Thursday will be crucial for European equities. Eurozone GDP data on Wed and UK GDP (Fri) will also be something to watch out for. US consumer price index (CPI) data on Thursday will be closely watched as well.
Tuesday 8 March: Germany Industrial Production (IP)
Wednesday 9 March: Russia CPI inflation
Thursday 10 March: ECB main refinancing rate; ECB deposit facility rate
Friday 11 March: UK monthly GDP
Monday 7 March
- Switzerland unemployment rate
- Germany factory orders
- US consumer credit
Tuesday 8 March
- Germany IP
- Eurozone GDP
- US trade deficit
Wednesday 9 March
- Russia CPI inflation
- Italy IP
- US JOLTS job openings
Thursday 10 March
- ECB meeting
- Italy Producer Price Index (PPI)
- US CPI and jobless claims
Friday 11 March
- UK monthly GDP; UK manufacturing and IP; UK construction output and trade balance
- Germany CPI
- Spain CPI
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1. Indices are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results.
2. One basis point is equal to 0.01%.
3.Source: Bloomberg Spot Commodity Index. Indices are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or a guarantee of future results. See www.franklintempletondatasources.com for additional data provider information.
4. Sources: BofA Global Investment Strategy, Bloomberg, Datastream.
5. Source: Food and Agriculture Organization of the United States, FAO Food Price Index. Data as of February 2022. Indices are unmanaged and one cannot directly invest in them. They do not include fees, expenses or sales charges. Past performance is not an indicator or guarantee of future results.
6. Source: Financial Times, “Russia’s invasion of Ukraine adds to pressure on chip supply chain,” 3 March 2020.