How Russia’s invasion of Ukraine changed financial markets
Investors say the conflict could make global inflation more entrenched
A year after Russian tanks rolled into Ukraine, markets have absorbed many of the short-term impacts, but investors say the conflict could have longer-lasting financial consequences.
The Russian ruble has gyrated, first tumbling against the dollar, then rebounding due to capital controls and an influx of petrodollars, then selling off again as energy sanctions started to bite. It is now roughly back to where it was preinvasion.
Similarly, the most heavily traded contracts for Brent crude oil spiked to $128 in the weeks after the invasion, from about $78 a barrel at the end of 2021, only to settle back down. As of Wednesday, Brent was trading at about $81. That is despite the imposition of Western sanctions on Moscow and retaliation from Russia, the world’s biggest oil exporter.
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Natural-gas prices have likewise endured a roller-coaster ride, as mild weather helped Europe avoid a disastrous winter shortage.
Still, some investors say the war could make global inflation more entrenched, as it disrupts world commodity markets, splinters supply chains and prompts nations to spend more on defense and energy security.
"It’s a butterfly effect. Ukraine and the commodity shock was the catalyst, but we’re worried that this has now evolved into structural inflation," said John Roe, head of multiasset funds at Legal & General Investment Management. "Prices were very contained for a decade, but now we have to invest in an environment where there’s a lot more uncertainty about this."
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The severing of Western ties with Russia also provides a template for how future wars may be fought on the economic battlefield, making it more important that businesses and investors don’t become too dependent on, or exposed to, any single market.
Investors are making stock picks based on the new geopolitical backdrop. Shaniel Ramjee, a fund manager at Pictet Asset Management, is buying shares of European industrial companies, expecting them to gain as the European Union weans itself off Russian gas.
"It’s going to be a longer-term project for Europe to regain energy security and that’s going to lead to a lot of investment," Mr. Ramjee said.
Defense stocks have outperformed. A subindex of the S&P 500 focused on aerospace and defense was up 12% as of Thursday, compared with its level preinvasion, even as the broad market index has retreated.
Another approach is to focus on the likelihood that prices for raw materials will remain elevated.
"As long as the war lasts, and as long as Russia is shut out of commodity markets, price pressures will remain," said Philipp Schoettler, cross-asset strategist at UBS Asset Management. "We’ve been long commodities for a while; it’s worked out for us."
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Some fund managers are preparing for a multiyear conflict. Europe’s largest asset manager, Amundi, recently increased the probability of a long-term war to 30%.
That calls for more caution, even after the major global stock markets started 2023 strongly, said Francesco Sandrini, Amundi’s head of multiasset strategies. Funds he helps manage are betting on a decline in stock prices.
Higher inflation means "we will not be able to count anymore on central banks to come to the rescue of investors, cutting interest rates as soon as the situation gets a little dirtier," said Mr. Sandrini. "It will be a market much less driven by abundance of liquidity."
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The war in Ukraine is just part of a complex market backdrop. In recent weeks, investors have cooled on the idea that the Federal Reserve is nearly done raising rates, given strong readouts on inflation, the labor market, retail sales and business activity. Government bonds have sold off, pushing benchmark 10-year Treasury yields up to around 3.9%, and in turn pressuring stock prices.
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As of Thursday, data compiled by the St. Louis Fed shows that the 10-year break-even inflation rate, which is based on bond-market yields, stands at about 2.4%. The figure suggests that investors expect inflation over the next decade to modestly exceed the Fed’s 2% target, which isn’t far off where it was in the days leading up to Russia’s February 2022 invasion.