Ukraine: Assessing the market impact and what comes next

Volatility spiked on Thursday and stocks whipsawed after the much-anticipated invasion of Ukraine by Russia. However, US stocks reversed course and finished the day in positive territory, after President Biden spoke out about events in Ukraine and announced a fresh round of sanctions against Putin’s cronies and the banks that are financing the campaign against Ukraine, although he stopped short at doing anything that could cause Russia to halt energy supplies to Europe. At the time of writing, the S&P 500 was up more than 1%, while the risk-sensitive Nasdaq 100 was up just less than 3%. The Dow Jones, which earlier on Thursday had fallen into correction territory after a spate of recent losses, was flat. Since the Dow is more closely linked to the performance of the economy, the surge in commodity prices on Thursday hurt this index more than it did its peers. 

The question that investors want to know is, when and how will this end? Considering there has been no serious military conflict in Europe since the Second World War, there is no playbook for this and the answer to this question is that we just don’t know. Instead, traders need to react to the news flow about the crisis, stick to short term trades and watch price action like a hawk. Below, we take a look at the four factors that will influence our trading decisions in the coming days. 

1, Commodities

Much has been written about the surge in commodity prices on Thursday, from European natural gas futures to the price of wheat, which surged 9% to its highest level since 2012. Russia and Ukraine are the world’s largest exporters of wheat, they are literally the world’s breadbasket, so how likely is supply chain disruption? Earlier this week, President Putin said that he would not turn off the supply of gas to Europe, and so far, this has not happened. However, although European Nat gas futures did fall back from their intra-day highs on Thursday, they are still up more than 30%, and are trading at 115.25 EUR per megawatt hour, this time last year the price was 16 EUR. In the UK, prices jumped 23%, and in the US, gas prices jumped 6.5%. This highlights how much more exposed Europe, and the UK are to this crisis compared with the US, and we expect it to play out in the performance of their stock markets in the coming weeks. The chance of Europe’s stocks outperforming US stocks in the short to medium term is extremely slim, in our view. Since Ukraine is such a crossroads for gas supplies to Europe, fighting in the country is likely to keep the price of gas and key commodities high for some time. However, the longer this crisis goes on for, the more one has to wonder whether or not Putin will actually pull the plug on Europe’s energy supply. Europe accounts for 38% of Russia’s energy exports, thus, even if Moscow is turning towards China and away from the West, China won’t be able to soak up all of the extra supply if Russia turns off the taps to Europe. This is why some analysts think that Putin has made a terrible mistake in targeting the Ukraine. 

The growing nuclear threat

However, we would argue that the mini relief rally in commodity markets on Thursday evening, the price of Brent crude backed away from $100 per barrel, may be short lived. Commodity markets remain skittish, and we expect commodity prices will remain elevated for some time. Although Brent had fallen back at one point on Thursday, it began climbing again after news that Russian forces had taken control of the Chernobyl nuclear plant, which has added an altogether more concerning dimension to this crisis: the prospect of Moscow using nuclear weapons to subdue the Ukraine. This is no longer a mere probability on a spread sheet. Ukraine is a huge country, and it would take approx. 600,000 Russian troops to subdue all areas of Ukraine, Putin has approx. 200,000 troops. Thus, a nuclear attack would be one way to subdue/ destroy Ukraine quickly, which is something that could spook markets as we move into the weekend. 

The broken link between commodity producers and commodity prices 

The impact of the crisis on commodity producers is not clear cut either. BP, which owns nearly 20% of Russian oil giant Rosneft, saw its share price fall more than 4.5% on Thursday, over concerns that sanctions could limit BP’s access to its profits from Rosneft, there are also growing calls for BP to ditch its Russian business in solidarity with Ukraine, something this ex. BP-er would be very surprised to see. Thus, with BP likely to hold firm to its Russian connections for now, we think that there could be more pain to come for its share price in the medium term. The same is true for Evraz, the steelmaker, owned by Roman Abramovich. Its share price slid by 30% on Thursday, after heavy losses in recent days, due to fears about the impact of sanctions on its Russian oligarch owner. As you can see in the chart below, for some metals and energy producers, their share prices have completely decoupled from the soaring price of the commodities that they produce. Thus, beware trading any commodity producer with links to Russia. 

Chart 1 

2,   Stocks and the Fed 

There is one silver lining for major global stock indices from this crisis: it could trigger a more cautious approach to tightening from the Federal Reserve. If commodity prices are surging, why would the Fed be cautious about tightening? While this is likely to impact inflation and keep inflation elevated, the Fed and other major central banks know that for as long as energy and other commodities are rising because of the Russia/ Ukraine crisis, their interest rate increases will not be able to dampen price pressures. The CME FedWatch tool shows how the market has reassessed its expectations for Fed rate hikes in the next three months. The market is no longer expecting a 50 bp rate hike from the Fed when it meets next week. There is now an 87% chance of one rate hike to 25-50bp, with an even chance that rates could reach 100-125 bps by July. Treasury yields have also fallen back, as US Treasuries have been in demand due to safe haven flows. 

3, Russia 

The impact from Russia’s incursion on the Ukraine has already had a huge impact on the value of Russian companies at home and abroad, and the Ruble fell to a record low versus the dollar on Thursday. With an autocratic lunatic in power, it is hard to see how the Ruble can recover any time soon. Likewise, the Russian stock market, the Moex, fell more than 20% on Thursday. These are brutal losses that will hurt the Russian economy and impact the wealth of regular Russian people. If this sparks protests and popular resentment against Putin and his cronies, then we could see a softening of his stance towards the Ukraine. The Russian economy was weak before the war started; it is now hobbled. In Turkey, President Erdogan only softened his stance towards economic policy when it became clear that it hurt his popularity and boosted the opposition. We will have to see if bully-boy Putin follows this logic. 

4, FX 

The volatility in the FX market has been notably mild during this crisis. Gold has been a major beneficiary, rising above $1,900 per ounce, the highest level since May 2021. We expect the price of gold to remain elevated until commodity prices start to recede in a meaningful way. The dollar has been the big winner, the dollar index is close to its highest level since July 2020 and at this moment, we don’t like the look of shorting the dollar as there could be more upside to come from continued safe haven flows. Even if the Fed does scale back some of its tightening ambitions, we still think that it will be hike rates at a faster pace than the ECB, which is another reason why we continue to favour the dollar. 

Crypto has proven that it is no substitute for gold in a crisis. It is close to some of its lowest levels this year, and although it rose nearly 3% late on Thursday, we still think that it is closely aligned to the fate of global risk sentiment and closely correlated with stocks. Thus, expect crypto to go where the Nasdaq does in the short term.