Your weekly economic update from the team at FXD Capital
After months of tensions, on Thursday, Russia announced its invasion of Ukraine. Modern warfare plays out in real-time, with minute-by-minute accounts more akin to football matches than human tragedy. Unlike historical events, modern wars are haphazard regarding the quality of real-time news being reported – the new trick is using stock photos of historic skirmishes to show incidents that aren’t actually happening. Considering that cyberwarfare is now a part of the modern-day arsenal, the complete deluge of information causes chaos in markets.
Despite the event being in the crosshairs for some time now and predicted right in the window between hard winter and the spring thaw, markets reacted in a turbulent manner. Russia bore the brunt of its actions, with the Moscow index at one point losing 33% of its entire market cap. The Rouble now trades at 90 to the dollar, its weakest ever position.
Markets almost all moved in the same direction, apart from some notable exceptions. Brent Crude crossed the $100 threshold for the first time in years, and European natural gas contracts rallied 10% to €87.9 per MWh. Wheat is now at 13-year highs – $9.61 per bushel – due to Russia and Ukraine accounting for 1/3 of global output. Gold also rose gently by 0.4% to close at $1,912 per troy ounce.
Conflict aside, the situation is delicate because the specific externalities of the war – commodities prices – represent a considerable weakness for western economies battling inflation. Moreover, the effect of wheat, oil and gas prices on systems already trying to plug inflation dykes that are only forecasted to reach 2% central bank rates means that a “new paradigm” may be entered, where the transitory inflation of Covid seamlessly segues into conflict inflation.
The perfect example of the trade-offs at play is the demurring about excluding Russia from the SWIFT payment system. The sanctions placed down by western governments are symbolic gestures similar to what ASBOs were in the UK: they look tough but are incongruous to actors that never play by rules in the first place. Yet, while there is talk about expropriating assets ranging from houses to football clubs, some nations don’t want Russia to be banned from SWIFT. The reason is that doing so may further exacerbate commodity inflation.
Russia accounts for 1.5% of SWIFT volumes, but 40% of its revenue comes from oil and gas exports. Exclusion from the system will result in their traders resorting to old telex-type trade methods. In addition, oil and gas importers will incur more bureaucracy, delays, and admin costs, which will turn the wheel of inflation further.
As seen last year in Afghanistan, the tragedy of the commons is that seeming binary decisions (“is this conflict unjustified?”) become secondary to butterfly-effect type notions of whether a reaction may unsettle economic decisions in tertiary countries. While 30 years ago, NATO engaged in intervention in non-NATO Yugoslavia and Kosovo, now its almost used as a perfect excuse for not intervening and threatening to upset economic decisions related to energy supply.
Stock markets had another week in the red, with a brief respite provided by American markets at the close of play on Thursday. While the S&P 500 lost 3% at one point, it had rallied 1.5% by the finish. The reason for the swing is more nefarious; far from investors buying the dip, the upturn was due to short-sellers covering rightfully-predicted bets that war would unfold. Conservatively covering some of their shorts ensures that the market wouldn’t tank in one fell swoop and suggests that the market will have less volatility than March 2020’s Covid event, which caught everyone off-guard.
With VIX volatility at 30, well over its long-run average of 20, the signs are that extreme uncertainty will persist for the year. All the prominent world actors appear to be in a state of flux due to the interconnected nature of all their problems. The optimists who predicted that Covid inflation would abate are slowly backing away, and it looks like it will be an expensive, uncertain year within markets.
All the best for the week ahead
Our weekly column is written by Alex Graham, Economic Advisor to FXD Capital. Originally a bank treasurer, Alex’s weekly roundup intends to provide a conversational, top-down view of what is going on in world macroeconomics and how it impacts business on the ground level.
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