Global stocks dropped, with US stocks suffering their biggest decline since 2020. US bond yields, the USD and gold rose amid rising concerns about energy and commodity supplies amid the escalating conflict in Ukraine.
Reports suggests Europe is considering barring Russian oil imports; Russia threatened to cut gas supplies to Europe. A significant decline in Russian energy flows would exacerbate supply shortages, increasing inflationary pressures.
Upcoming ECB and Fed meetings will be closely watched for signs of whether policymakers prioritise supporting growth over fighting inflation. Long-term inflation expectations are breaking higher, putting further pressure on central banks.
The impact of the Russia-Ukraine conflict on global energy commodity markets deepened, with crude oil prices surging to their highest since 2008 and European gas, copper, wheat and palladium prices hitting all-time highs, as the US and Europe considered banning Russian oil imports.
The US S&P500 index slumped 3%, the Nasdaq index fell 3.8% – testing its 100-week moving average – and the benchmark for global stocks (MSCI All Country World Index) fell 2.7%. European stock benchmarks fell to their lowest in a year. In commodities, the WTI oil price surged above USD 120/bbl. Gold tested USD 2,000/oz, its highest since August 2020, while EUR/USD slumped below 1.09 to its lowest since May 2020.
Sentiment, stagflation risk:
The continued surge in commodities is likely to further hurt investor sentiment in the near term. High energy prices reduce disposable income of consumers, while fuelling inflation pressures. The escalation of the Russia-Ukraine conflict and tightening Western sanctions against Russia in the past week has raised stagflation risks (stagnant growth and rising inflation).
Ban on Russian energy exports:
In the latest Weekly Market View, SCB discussed the three red lines of the Ukrainian crisis, the second of which is whether oil and gas continues to flow from Russia. US and European plans to ban imports of Russian oil imports suggest the risk of crossing this second ‘red line’ has increased. However, reports suggest Russian oil continues to flow into Asia as countries in the region take advantage of price discounts to boost stockpiles. Meanwhile, Russian gas flows to Europe were already falling before the conflict started. A total ban on imports would of course push energy prices dramatically higher. This would be worrying for investors as it leads to the worst-case outcome of higher inflation and slower growth.
Central bank policy:
Against this backdrop, the upcoming ECB and Fed policy meetings (10 March and 15-16 March respectively) will be closely watched, not just in terms of what they do, but also for a framework of how they plan to address the situation going forward. The key question is the degree to which they are willing to look through near-term inflation pressures and focus on supporting growth?
The ECB is likely to reverse plans to wind down its bond-buying programme (APP) as the energy price shock severely impacts growth. However, the Fed is likely to remain focused, for now, on inflation as medium-term inflation expectations break higher. The Fed’s new projections for medium-term growth, inflation and rate hikes will show whether policymakers are becoming more concerned about a growth slowdown later this year.
Stay invested and diversified, hedge:
It is worth bearing in mind that military conflicts do not usually have a lasting impact on markets. It is normal for equity markets to recover strongly from geopolitical-related sell-offs within the ensuing 6-12 months. Therefore, history suggests the best course for investors is to stay invested in a diversified allocation and to hedge near-term risks. Gold and energy assets have performed well in recent weeks. USD, CNY and Chinese government bonds have also been relatively resilient.
Technicals: WTI crude oil has broken above the prior resistance of USD 112-115/bbl, opening the path towards a retest of the 2008 high of 147. The US S&P500 index’s break below 4,201 opens the way to as low as 3,750.
