Markets Drop on US Sanctions. Weekly Report – Ukraine, Inflation and Stagflation

S&P 500 2-28

The Ukraine/Russian conflict has escalated into a full-blown war. The Russians were expected to quickly take the country, but the Ukrainians resisted and stalled out the Russians. Peace talks have been on and off. The Russian economy (stock market and the Ruble currency) have have taken a huge hit. The US stock market initially took a dip but has somewhat recovered. Investors appear quick to jump in at the slightest positive news.

There appear to be some rumors that the Fed will wait to raise rates if the Ukraine/Russian War rages on, but most Fed watchers are still expecting rate increases. Fed talk will likely cause market movements in bonds this week if they appear dovish.

Key Market Movers

  • Ukraine Conflict
  • Rising Inflation & Recession Fears
  • Fed Hikes & Fed Talk
  • Thursday, March 3 – Factory Orders (MoM) (January)
  • Friday, March 4 – Unemployment Rate (February)

As Ukraine’s fight against the Russian invasion enters its fifth day, a risky day is upon us. Investors are watching the headlines and waiting for news on a diplomatic solution.

Ukraine War NOT Moving Markets?

The war has had a relatively muted reaction from the financial markets. This morning the markets are down, but last week it bounced back.

Maybe that’s because it is the right way to do things. The bond market’s reaction has been muted so far, which suggests that investors have not significantly changed their macro outlook. The yield curve, forward-looking inflation expectations, and bond yields have remained steady. Inflation expectations have not changed much despite the possibility of higher grain and energy prices due to the conflict.

Rising inflation fears are leading to Stagflation fears in both the US and Europe. We believe the risk of stagflation is certainly increasing, it is still too early to consider stagflation in US and Europe. There are many uncertainties regarding the future direction of energy prices, including whether sanctions will be extended to agricultural and energy sectors and possible government fiscal responses.

The Fed and central banks may not have a choice to not raise rates and will be forced to raise them. How much and when is the question. Historically the Fed has not been aggressive as to not stir the markets too much.

VIX Volatility

VIX is trading at 32.5, the highest level since January 2021, and currently stands at +18%. Most people forget that panic protection is often a costly strategy, and VIX trades at extremely high levels unless this happens (and S&P 500 is not going down by 1.5%). We have seen volatility rise lately.

Russia & Ukraine Economic

Russia and Ukraine contribute 2% to global GDP in terms of (1) economic impacts. (2) Financial contagion is minimal, as Russia’s exposure to banks is $100bn. (3) Risk aversion-related conflict might have already peaked. The market tends to overprice unknowns, which leads to the “buy fact” pattern. Scale invasion was more severe than expected, but the absence of a quick win likely lowers the spread. (4) The final and most important channel is commodity prices.

This is especially true given the high level of inflation that central bankers are concerned about. JPM forecasts were revised up, resulting in modest stagflationary macro revisions. There is hope: energy exports that are not subject to sanctions remain open. Crude oil upside ($110 for 2Q) is possible thanks to potential Iran supply SPR release. All of these dynamics could explain why US equity ended higher last week, despite a -6% drawdown” JPM.

While Ukrainian and Russian delegations are currently at the Belarusian frontier, fighting in Ukraine continues. This is after a tension-filled weekend that saw Russian President Vladimir Putin increase tensions by moving Russia’s nuclear forces into high alert. According to reports, Belarusian troops may be prepared to fight alongside Russia.

After Western allies agreed to remove some Russian banks from the SWIFT global payment system, Russia’s central banking doubled its interest rates. The ruble ( ROUBUSD has fallen, and London listed stocks have slumped.

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US and European defense contractors Raytheon (RTX), Northrup(NOC), and General Dynamics (GD) are accelerating Germany’s surprise decision to increase military spending and send weapons to Ukraine.

NASDAQ Magical 14k

NASDAQ futures has put in yet another hammer reversal candle. Support is at 13800 and 13400. The negative trend line at 14200 is resistance, followed by the 14400 level (the 21-day moving average). Let’s watch how it develops. Tech is becoming trapped between the supports & the negative trend line. People have bought the rest of the world and puked tech.

Buffet – No excitement

Berkshire Hathaway ( .A) ( .B). CEO Warren Buffett stated that there is “little to excite us” about the US stock market in Saturday’s annual shareholder letter. Its energy unit promised to continue reducing carbon emissions.

Bonds

Bond yields have continues to trend bullish due to Fed raising rates. The Ukraine War may put pressure on the Fed not to increase rates at the same pace, but most Fed watchers remain hawish.

Financial advisors and investors should take note that the US 10YR yield went over 2% which is over the average S&P 500 dividend. Bonds are getting crushed, but we think investors will start moving out of equities into higher-paying conservative investments such as CDs.

Crypto

Bitcoin and its peers are testing Crypto investors. Although the price of the cryptocurrency seemed to be in a bullish trend over the last few days after taking losses last month. Investors may be reluctant to invest in risky assets due to the tight geopolitical environment. However, we see cryto becoming more and more an “established” currency.

OIL

Oil markets remain sensitive and tightened as the Ukrainian war continues to be a concern. Prices have slowed down slightly this week, ending an eight-week streak that had seen consecutive increases. However, this morning it appears that there has been a new strong bull trend.

While traders are closely monitoring developments in Ukraine they also monitor the Iranian nuclear talks which appear to be moving in a positive direction. Iran stated that they were close to reaching a deal, which is raising hopes that Iranian oil will soon be available on global markets. Brent crude oil currently trades at USD 95 per barrel

Precious Metals

Just like oil, geopolitical tensions have an impact on precious and industrial metals. Gold’s status as a safe haven is helping to bring it back into the spotlight. The gold price has risen to 1900 USD.

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