How a Russian invasion of Ukraine could send shockwaves through the market

The threat of a devastating European ground war has done little to rattle financial markets so far, but investors still seem likely to snap up traditional safe-haven assets if Russia attacks Ukraine, market watchers said.

In this case, the “typical kind of conflict responses” would likely be in play, including moves into long-duration Treasuries, as well as a spike in European oil and natural gas prices, Garrett DeSimone, head of of quantitative research at OptionMetrics, says MarketWatch. Such moves would likely be short-lived, he said.

Talks continue

Senior US and Russian diplomats met Friday in Geneva. Talks appeared to be making little headway, but officials vowed to continue talks in a bid to defuse the crisis.

Read: U.S., Russia agree to continue talks aimed at defusing Ukraine standoff

Moscow has moved around 100,000 troops near Ukraine in response to what it says are threats to its security from the North Atlantic Treaty Organization and Western powers. The move stoked fears of a Russian attack.

While a direct military response from the United States and its Western allies is seen as off the table, President Joe Biden has promised tough sanctions. Russia, a key energy supplier for Europe, would likely use these resources as leverage in response to Western sanctions.

Uncertainty around the answer, however, grew after Biden, at a press conference on Wednesday, said a “minor incursion” by Russia into Ukraine would spark a fight between the United States and its allies. on the measures to be taken. On Thursday, Biden moved to clarify his remarks by saying, “If assembled Russian units cross the Ukrainian border, it’s an invasion” and that if Russian President Vladimir Putin “makes that choice, Russia will pay a heavy price.”

All about energy

Russia’s annexation of Ukraine’s Crimean peninsula in 2014 created bouts of volatility, but nothing has caused global markets to lose momentum, noted Steve Barrow, head of G-10 strategy at Standard. Bank, in a note. Investors, however, cannot count on such a muted reaction to a large-scale invasion, he said.

Russia’s role as a natural gas supplier to Western Europe means energy prices could trigger bouts of volatility in other financial markets. A conflict between Russia and Ukraine would likely cause natural gas prices to spike, even if it’s just a knee-jerk reaction, Barrow said.

Earlier: Tensions between Russia and Ukraine mean natural gas volatility in Europe unlikely to fade

“Presumably other energy prices would rise in tandem and that could disrupt financial asset prices in a way that turns out to be much more significant than what we saw in 2014,” he said. . “Safe haven demand would likely increase for assets such as Treasuries, the dollar, the yen and the Swiss franc.”

Read: Tensions between Russia and Ukraine are not fully priced into commodities

Policymakers in Washington have signaled they will try to exempt energy from a crippling set of financial sanctions being prepared, but “there is a clear expectation that Moscow will seek to militarize energy exports in order to to change the decision calculus in Western capitals,” said Helima Croft, head of global commodities strategy at RBC Capital Markets, in a Wednesday note (see chart below).

RBC Capital Markets


It has created a scramble to secure extra gas supplies for Europe to offset a sharp cut in Russian exports, she said, although the question is “where to find those extra volumes”.

While liquid natural gas cargoes can be diverted from elsewhere, U.S. LNG export capacity was in the 90% to 95% utilization range so far in January, leaving limited additional capacity available. , and globally,” she wrote.

A combination of factors, including nervousness over Ukraine and reduced Russian gas pipeline flows, have been blamed for soaring natural gas prices in Europe this winter. Dutch natural gas futures are up more than 13% year-to-date after more than tripling in 2021.

“A Clearly Positive Dollar”

Energy-related volatility would likely result in gains for the US currency against the EURUSD,
+0.31%,
wrote strategists at ING, in a Friday note.

“Any escalation should be clearly positive for the dollar – as Europe’s reliance on Russian energy exports will be further exposed,” they said.

Meanwhile, gold, which posted a weekly gain, could also benefit from safe-haven flows, Standard Bank’s Barrow said, “although its trajectory is harder to follow and will likely depend on dollar strength,” did he declare. Indeed, a surge in the dollar, which can be negative for commodities priced in the currency, would leave the yellow metal struggling to emerge from contention.

Financial markets had a volatile start to 2022. US equities were heading for another losing week, with the tech-heavy Nasdaq Composite COMP
-2.72%
having already slipped into correction territory as it fell more than 10% from its peak in November. The Dow Jones Industrial Average DJIA,
-1.30%
retreated to a level last seen in early December, while the S&P 500 SPX,
-1.89%
closed Friday at an over-three-month low.

Geopolitics or macro?

The decline in stocks was largely attributed to shifting expectations around the Federal Reserve rather than geopolitical jitters. The Fed is expected to be much more aggressive than expected in raising interest rates and otherwise tightening monetary policy in response to inflation.

Indeed, a Fed-inspired sell-off in the Treasury market spilled over into other assets as yields, which move in the opposite direction of prices, rose sharply to start 2022. In the event of a geopolitical flare-up which sparks a classic flight to quality as risk-averse investors seek shelter, yields are expected to fall sharply.

The 10-year Treasury yield TMUBMUSD10Y,
1.762%,
which hit a two-year high near 1.9% on Wednesday, fell back on Thursday and Friday to trade below 1.75%, although the renewed interest in buying is tied to technical factors and also seen as a response to the deepening of the stock sale rather than related to paradise buying.

Notably, short-term futures on the Cboe VX00 Volatility Index,
+5.60%
have moved past future-date contracts, inverting the so-called futures curve — a move that signals investors are seeing increased risk of short-term volatility, DeSimone told OptionMetrics, but noted that the move also reflects probably Fed concerns.

Meanwhile, the VanEck Russia RSX exchange-traded fund is down more than 13% so far in January and has fallen more than 30% from a more than nine-year high reached in late October. The Russian ruble USDRUB lost more than 3% against the US dollar in January.

Past lessons

When it comes to stocks, perhaps the takeaway from past geopolitical crises is that it’s best not to panic-sell, MarketWatch columnist Mark Hulbert wrote in September.

He noted data compiled by Ned Davis Research examining the 28 worst political or economic crises in the six decades leading up to the September 11, 2001, attacks. In 19 cases, the Dow was higher six months after the crisis began. The average gain over six months after the 28 attacks was 2.3%. In the aftermath of 9/11, which left markets closed for several days, the Dow fell 17.5% to its low but recovered to trade above its 9/10 level on October 26 , six weeks later.

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