At minimum this halts Europe’s economic recovery, and the energy shock risks a recession
Publishing date:
Feb 24, 2022 • 16 hours ago • 4 minute read • 27 Comments
Smoke rises from a power plant after shelling outside the town of Schastia, near the eastern Ukraine city of Lugansk. Photo by ARIS MESSINIS/AFP via Getty Images Vladimir Putin finally did it, with a full-scale invasion of Ukraine despite all diplomatic efforts and significant sanction threats from the West that will severely damage the Russian economy. But for the Kremlin, this isn’t about gross domestic product as much as a deep well of nationalism, and the primary aim is to complete Donald Trump’s job in terms of undermining North Atlantic Treaty Organization (NATO). In any event, Putin couldn’t have picked a better time in terms of exposing the complete lack of global political leadership.
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From an investing standpoint, geopolitical events tend to be brief trading events, but this situation has added complications in terms of the pandemic and still-strained global supply chains, the switch from fiscal tailwinds to headwinds and, of course, the shift toward monetary policy restraint. It must be understood that the escalation in this Russia/Ukraine file is occurring at a time when risk-on markets were already under significant stress.
At a minimum, this halts the economic recovery in Europe, and the energy shock is risking a recession — natural gas on the continent jumped 30 per cent overnight Wednesday. The economic knock-on effects are big, given the European Union commands the largest chunk of global GDP.
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Pundits talk about inflation, but this is actually also a depressant on demand, so it cuts both ways: energy shocks are de facto taxes on consumption and a drain on real purchasing power. In a nutshell, look for equities to head even lower, especially the most cyclical sectors of the market.
Treasury yields will reverse this most recent backup (the rally will be constrained by the “inflation” aspect to this, but the safe-haven status will dominate now), and most commodities will rise, which means Treasury inflation-protected securities (TIPS) will be in play. Oil prices have already broken above US$100 per barrel for the first time since 2014 (Brent was up 8.4 per cent overnight Wednesday) and the backwardation (signalling super-tight supplies) is deepening; the base metals from copper to nickel to aluminum have spiked.
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Look for equities to head even lower, especially the most cyclical sectors of the market
Food prices are setting new record highs. Gold (futures up 3.3 per cent to US$1,971 per ounce) and silver should benefit as well. And the deep dive in bitcoin and its counterparts showcases how the cryptocurrency space is actually far from a “currency” you can rely on for refuge in troubled times — exposed really as a high-beta-correlated trade with the stock market. Credit spreads will widen out as will credit-default swaps, especially in Europe.
As for the United States Federal Reserve, it is boxed in, but one can reasonably expect that any move on March 16 will be accompanied by a more dovish press statement. Surely, monetary officials can’t be that myopic unless causing a demand-led recession is their ultimate goal. Even if the Fed feels boxed in enough to still lift rates on March 16, the futures market will not be sticking with the current pricing of six rate hikes this year, so these aggressively priced eurodollar strips are a screaming buy.
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In the currency market, selling the euro against virtually any currency is the most prudent move at the moment, especially against defensive units such as the yen and/or commodity currencies like the loonie, Australian dollar and New Zealand kiwi.
The fact that Putin has decided to go all in instead of piecemeal is a sign that he is in for the long haul, and it won’t just be Ukraine that is in his sights
The key here is that risk aversion will escalate and liquidity preference will accelerate. Stepped-up sanctions are going to exert a powerful inflationary tax on the world economy because the one thing we know with certainty is that Russia is the biggest exporter of wheat and fertilizer, and the third-largest exporter of crude oil and coal, while supplying 40 per cent of Europe’s energy needs.
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Article content The other thing we also know about Putin is that he likely won’t respond to sanctions and we can also be certain the Russian population knows all about how to live with substantial economic pain (keeping in mind that Russia has already been under U.S.-led sanctions for the past seven years and its economy has largely adjusted).
The final point is China’s role in all this, as its near-pariah status in the rest of the world has pushed Beijing into an alliance with Moscow and this friendliness will likely help blunt the blow to the Russian economy. The fact that Putin has decided to go all in instead of piecemeal is a sign that he is in for the long haul, and it won’t just be Ukraine that is in his sights (Belarus, Kazakhstan).
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Article content One is always tempted to draw on similar events in the past for comparison purposes, but few really apply. Perhaps the most relevant would be the Iranian revolution and hostage taking in 1979-80 that also took place under a cloud of a weak U.S. administration, a global political leadership vacuum, an energy crisis, escalating inflationary pressures and a zealous Fed. What came next were two recessions spread less than two years apart and a prolonged bear market in equities.
David Rosenberg is founder of independent research firm Rosenberg Research & Associates Inc. You can sign up for a free, one-month trial on Rosenberg’s website.
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