The invasion of Ukraine by Russia is the latest geopolitical risk to rile the market. While this risk began to appear as a concern back in 2014, it has become one of the chief risks of 2022. Sanctions are the Western attempt to solve conflicts by disincentivize the ongoing hostilities, but there is always a struggle deep down. Since we are not privy to the innerworkings of the political machines, it can be challenging to have meaningful discussions about what we should or shouldn’t do. Opinions are easy to talk about, but solutions are always more challenging. That is compounded by the reality that countries are affected differently by various sanctions.
At the time of this commentary being written, we only a few sanctions have been announced, which are primarily focused on the Russian financial sectors and lawmakers, as well as Russian corporate finance on the international front. So far, the West has not placed a full embargo on the main export of Russia, likely to give diplomacy more time, and to plan for how to replace the energy exports that the world uses from Russia.
Oil and energy prices are one of the areas that have risen dramatically over the past year and jumped over $100/barrel at the beginning of the Russia invasion.2 Oil prices have contributed to the increased inflation the US is dealing with, which started with Biden’s cancellation of the XL Pipeline and limited drilling leases.1 The Russian war on Ukraine is likely to keep oil prices elevated for the time being.
This change may have an impact on the Fed’s current plans. The market expectation is no longer that the Fed will hike rates in March to 50-75 basis points, but now has an expectation of only one quarter point hike in March, with a more measured hike over subsequent meetings (see chart below).
The Fed already had a challenge to address inflation without slowing down corporate growth too much. However, with potentially rising energy prices in the short term, along with sanctions that affect the whole world, that job has become more challenging.
The good news is that if history is a guide, oil prices are unlikely to remain this high for an extended period, and therefore have likely only affected Fed timing momentarily. According to data compiled by Ned Davis Research, going all the way back to the invasion of Kuwait, Oil prices have not remained persistently high due to geopolitical or natural disaster disturbances. In fact, prices tend to come down dramatically 6-7 months after the initial event (see chart below).
If that same trend holds true, the West will likely find a solution to replacing the energy lost by any potential Russian embargos, sanctions, or limits. Other possibilities include a diplomatic outcome that does not result in further energy price pressure.
Either way, upper price pressures in the past have not had an enduring impact, which would tend to support short-term inflationary pressure in energy. If that is true, the Fed should be able to adjust their plans to stabilize inflation, and hopefully, not cause corporate activities to contract.
The environment will likely continue to develop over the coming months and, therefore, remaining flexible in terms of strategy is key. Sadly, none of these things can console the innocent people that suffer in times of war and trouble, and our hearts go out to those suffering in Ukraine.
To help keep our clients and readers up-to-date, we are hosting a Live Market Update, Navigating 2022, which will feature key note speakers from our research partners, Ned Davis Research. Don’t miss this upcoming webinar!
- Biden Cancels Keystone XL Pipeline Permit. Institute for Energy Research. January 25, 2021 [2/25/22]
- Stocks and Energy Markets Whipsaw After Russian Attack on Ukraine. The New York Times. February 24, 2022 [2/25/22]
- Target Rate Probabilities for 16 March 2022 Fed Meeting. CME Group Fed Watch Tool. [2/25/22 at 9:00am PT]
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