Commentary on financial market developments – February 2022
Highlights:
- War conflict in Ukraine
- Oil – a sharp increaseChanges in selected stock indices and commodities:
Commentary:
Russia’s military attack on Ukraine has shaken global markets. Russia itself is among the biggest losers in economic and financial terms. It has led to the imposition of extensive economic sanctions not only by Western countries against Russia and a number of Russian companies and individuals linked to the Kremlin. One of the major economic bombshells was dropped in the form of cutting off several Russian state-controlled and private banks from SWIFT. At the same time, the EU and allies have moved to effectively freeze the assets of the Russian central bank, minimizing the central bank’s ability to intervene to stabilize the ruble or the government’s ability to use foreign exchange reserves to finance spending. The announcement of the sanctions triggered a “run” on Russian banks and Russia temporarily restricted the convertibility of the ruble.
Trading in Russian equities and bonds has been suspended on the Russian market and has also stopped for companies not directly affected by the sanctions, as it is unclear whether these companies will be able to continue regular business activities or debt servicing. The uncertainty has also led to a de facto suspension of trading in bonds of Russian companies on Western markets until the exact details of the sanctions regime become clear. This should allow a partial relaxation of the current restrictions, as most private Russian companies and the energy sector, led by Gazprom, are not affected by the current sanctions, and presumably the possibility of conducting international transactions not subject to sanctions through a selected segment of private Russian banks should remain. Examples of such transactions are repayments of debt already issued or transactions related to international trade. The attitude of the Russian authorities will be important. Exporters have been obliged to convert 80% of their revenues into roubles since the beginning of this week and brokers cannot implement foreign investors’ instructions to sell rouble-denominated stocks and bonds. The degree of easing of these measures will depend on the level of stress in the Russian financial system and the extent of any reciprocal sanctions by Russia against Western countries.
Rating agencies have subsequently downgraded Russia’s credit rating to the default threshold. The Russian economy itself will face the threat of a deep recession combined with high inflation this year. From the point of view of Russia and the financial markets, it remains crucial that exports of gas, oil and other commodities to world markets are not halted, even though supply disruptions are already occurring. Oil prices near 2008 highs Oil prices have continued to rise to multi-year highs in recent days. In fact, trade disruptions and shipping problems due to sanctions on Russia have raised supply concerns. Meanwhile, oil stocks in the United States have fallen to multi-year lows. The price of North Sea Brent crude oil briefly exceeded USD 139 per barrel and rose to its highest level since 2008. The price of US WTI light crude oil is at its highest level in 11 years. The rise in commodity prices is reviving fears of the coming stagflation, characterised by economic stagnation, high inflation and high unemployment.
The conflict in Ukraine is leading to increased uncertainties and a weakening of Central European currencies. Stocks in Central Europe have seen strong declines in the wake of the war. Russia’s invasion of Ukraine at the end of February came as a shock to markets. Banks and companies with large exposure to Russia and Ukraine lost the most, while energy titles were among the few to rise as they benefited from sharp rises in energy prices. The US S&P 500 reported a 3.1% loss for February and Europe’s Stoxx Europe 600 erased 3.6%. Corporate results for the fourth quarter still managed to please, with a positive surprise rate of 76% in the US and 62% in Europe. Government bond prices in Germany and the US fell in February on bets of tighter monetary policy. However, the beginning of March was marked by a rise as uncertainties stemming from the conflict in Ukraine are likely to lead to more gradual moves by the Fed and the ECB. Even so, the US Fed is expected to raise interest rates in March. Prices of koruna government bonds rose in response to the CNB’s forecast, which is working on a drop in interest rates from the second half of this year. But Central European currencies, including the koruna, weakened and inflation risks rose for the coming months. The CNB’s next steps could lead to a further rise in interest rates: the repo rate could be raised by 25 or 50 basis points from its current level of 4.50% at the end of March.
The Russian invasion of Ukraine has caused a reversal of sentiment on financial markets. For most of February, high inflation and bets on faster monetary tightening by both the Fed and the ECB dominated as the theme, leading to a rise in government bond yields. The conflict in Ukraine represents a stagflationary shock to Europe.