BlackRock Commentary: Ukraine war to cut growth, up inflation

Alex Brazier, Deputy Head of the BlackRock Institute together with Wei Li , Global Chief Investment Strategist, Elga Bartsch, Head of Macro Research and Nicholas Fawcett, Member of the Economic and Markets Research Team all forming part of the BlackRock Investment Institute, share their insights on global economy, markets and geopolitics. Their views are theirs alone and are not intended to be construed as investment advice.

Key Points:

Macro impact – We see the Ukraine war reducing global growth, increasing inflation and putting central banks in a bind. We prefer developed stocks in the inflationary backdrop.

Market backdrop – Stocks led by European equities bounced from 2022 lows last week, as oil prices came off highs. The European Central Bank accelerated policy normalization.

Week ahead – The Fed is set to raise its policy rate by 0.25% this week – the first hike since the pandemic started. We still see a historically muted response to inflation.

The war in Ukraine has already caused a terrible human toll. We see it extracting a heavy economic price as well, mostly via higher energy costs. This is a major supply shock layered onto an existing one, and we see it resulting in higher inflation and lower growth, especially in the euro area. This puts central banks in a bind: Trying to contain inflation will be more costly, and they can’t cushion the growth shock. We prefer developed equities in this inflationary environment.

Ukraine war to cut growth, up inflation Article Image 1

The Ukraine war has caused a spike in energy prices, putting a damper on growth and exacerbating supply-driven inflation. Europe is most exposed. Natural gas prices have surged beyond 2021 peaks, as the red line in the chart shows, before reversing a bit last week. The big difference with 2021: High energy prices are now the cause of a downdraft in growth, whereas they were the outcome of strong growth then. The culprit is Europe’s reliance on Russian gas in an already tight market. The powerful economic restart from the Covid-19 shock in 2021 had already exposed mismatches in the region’s energy supply and demand. This was aggravated by a mix of geopolitical factors and weather-related supply disruptions just as European inventories were low. The recent surge in European energy prices has pushed the region’s energy burden as a percentage of GDP to above levels reached in the early 1970s, we calculate, whereas the U.S. is still well below it. This is why we think the impact of the current energy shock for Europe could be on par with previous severe episodes such as the 1973 oil embargo.

Higher energy prices are a material, global shock. Europe is facing a large, stagflationary shock, in our view.  Analysts are ratcheting down their growth forecasts and upping their inflation projections. This is not over, and we believe the European Central Bank (ECB) growth forecasts understate the shock’s impact on growth. The U.S. is in a better spot, in our view. The shock is less than previous energy crises. The U.S. also has a larger growth cushion thanks to the strong restart’s momentum – even if some of European weakness is bound to spill over.

How will policymakers respond to the poisonous combination of slowing growth and rising inflation? Central banks have to normalize policy as the economy no longer needs stimulus, we believe, so policy rates are headed higher. The ECB last week said it would phase out asset purchases and left the door open for a rate increase this year – the first in more than a decade. The U.S. Federal Reserve this week is expected to announce its first rate hike since the Covid shock, while the Bank of England and a slew of emerging market central banks are set to hold rates or raise them. We still see a historically muted cumulative response to inflation; more aggressive tightening would come at too high a cost to growth and employment. Central banks will be forced to live with inflation. But it’s tough to see central banks coming to the rescue to halt a growth slowdown in this inflationary environment. Our conclusion: central banks are less likely to shape macro outcomes going forward. That leaves fiscal support. The war has raised the prospect of fiscal stimulus to achieve energy security and up defense outlays, but we see this taking time. 

The imminent hit to growth has reduced the risk that central banks slam the brakes and aggressively raise rates to contain inflation. So what are the risks? In the short run, escalation of the war and more energy supply shocks are key catalysts for more risk-off market moves. We see a risk of inflation expectations becoming unanchored in the medium term, causing central banks to raise rates sharply. Energy prices are now driving growth, rather than being the result of it. This raises the specter of stagflation–something that was not in play before due to the economy’s strong growth momentum.

What does this mean for investments? We prefer to take risk in DM equities against the inflationary backdrop of negative real bond yields. We expect the global energy shock to hurt corporate earnings, especially in Europe. Recent market declines reflected this, we believe, and the region’s stocks are highly geared toward global growth. We stay underweight government bonds. They are losing their diversification benefits, and we see investors demanding greater compensation for holding them amid higher inflation and larger debt loads. Within the asset class, we prefer short-dated and inflation-linked bonds.

Ukraine war to cut growth, up inflation Article Image 2

Market backdrop

Crude oil prices shot up to 14-year highs on supply concerns but then suffered their biggest one-day decline in almost two years. Equities followed suit, rebounding from plumbing new 2022 lows earlier in the week. The ECB said it would phase out asset purchases in the third quarter and left the door open for a rate increase this year. Peripheral bond spreads widened.

Week ahead

March 15 – China industrial output and retail sales; UK unemployment data
March 16 – Fed monetary policy meeting; Brazil rate decision
March 17 – UK, Indonesia and Turkey rate decisions
March 18 – Russia rate decision

The U.S. Federal Reserve is expected to raise its policy rate for the first time since the Covid shock. The Bank of England (BoE) is set to announce its third hike, and a slew of emerging market central banks are set to hold rates or raise them.  Both the Fed and BoE are keen to normalize policy rates back to pre-Covid settings. We don’t expect them to go beyond that to try to squash high inflation as the costs to growth and employment would be too high. We see central banks living with inflation.


BlackRock’s Key risks & Disclaimers:

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of February 28th, 2022 and may change. The information and opinions are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This material may contain ’forward looking’ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.

The information provided here is neither tax nor legal advice. Investors should speak to their tax professional for specific information regarding their tax situation. Investment involves risk including possible loss of principal. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation, and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are often heightened for investments in emerging/developing markets or smaller capital markets. 

Issued by BlackRock Investment Management (UK) Limited, authorized and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL.


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If you invest in this product you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest in a mutual fund should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.

Notes from the Trading Desk – Franklin Templeton

Franklin Templeton’s Notes from the Trading Desk offers a weekly overview of what our professional traders and analysts are watching in the markets. The European desk is manned by eight professionals based in Edinburgh, Scotland, with an average of 15 years of experience whose job it is to monitor the markets around the world. Their views are theirs alone and are not intended to be construed as investment advice.

The Digest

Last week was another week of turmoil for global equity markets as investors struggle to get to grips with the broader potential impact of the Russian invasion of Ukraine. There was some clear divergence between different regions. European equities saw some respite, bouncing off their lows on some tentative signs of progress in peace talks mid-week (although little progress came from talks). US markets lagged as they caught up with recent losses in Europe and inflationary pressures remain a concern. Asian equities also lagged as COVID-19 concerns continued to weigh on sentiment in China. On the week, the MSCI World Index declined 1.9%; the STOXX Europe 600 Index was up 2.2%; the S&P 500 Index was down 2.9% and the MSCI Asia Pacific was down 4.5%.

Markets at the Mercy of Headline Risk

Last week saw extreme volatility, particularly in Europe, as investors traded from one headline to the next on the Ukraine crisis.

We saw some aggressive moves higher in European equities on Wednesday after the somewhat perceived improvement in tone around peace discussions. The STOXX Europe 600 Index rose 4.7%, a bigger move than the COVID-19-vaccine discovery day and biggest gain since March 2020. Germany’s DAX was up 7.9%, a clear reversal of recent trends. Given we have recently seen extreme moves lower, markets seem more susceptible to good news than bad news, hence markets squeezed higher. In addition, the fund flow data (Wed to Wed) illustrated how much investors had reduced exposure to European equities, with another record week of outflows of US$13.5 billion for the region’s equities.

Nothing substantive came from peace talks between the Russian and Ukrainian foreign ministers, with some fairly barbed comments from both sides after the meeting. However, markets were volatile again on Friday after a vague comment from Russian President Vladimir Putin that there had been positive shifts in talks with Ukraine. This was later dismissed by Ukraine, but it was enough to see European equities spike higher and end the week in positive territory. Overall, it demonstrates how nervous investors are around missing any move higher, given that exposure to the region has been reduced sharply in recent weeks.

Looking away from equity markets, commodity markets also remained volatile through the week. Crude oil was in focus, as the United States and United Kingdom announced plans to stop the import of Russian crude oil. In addition, there has been a push to find alternative supply, with the United Arab Emirates reported to be calling on OPEC+ to increase oil production faster that currently projected and, remarkably, the United States is looking at easing restrictions on Venezuela, which could see an additional 400k barrels/day come to market. Of the five million barrels of crude oil Russia exports each day, about 50% goes to Europe. Russian imports account for 8% of total UK oil demand. The United States is less reliant, with 3% of imported oil coming from Russia in 2020. With that, West Texas Intermediate crude oil fell 5.5% to US$126.39 last week.

Gas markets were also volatile, although by the end of the week European gas had fallen 30% (still up +65% year-to-date). There was also a little profit-taking in wheat, but concerns over food price inflation remain. The UN Food Price Index is +23% year-to-date, risking increased pressure on consumers globally.

European bond yields widened (the German bund moved from -10 basis points to +30 basis points [bps] last week) and European credit spreads remained wider that recent levels, but still far from the levels since in 2020.

Looking ahead, any progress in peace talks will likely see markets squeeze again. Ukraine President Volodymyr Zelenskyy said there were talks over a possible meeting between himself and Putin. He also said that there were daily video talks between his representatives and the Russians. However, this is against a backdrop of escalating violence in many Ukrainian cities and a widening of Russian bombing targets over the weekend.

Another key date to watch this week is 16 March, when US$117 million in interest payments on a Russian sovereign bond is due to be paid out. Russia has suggested it will pay international holders in “unfriendly countries” in rubles instead of dollars. Fitch downgraded Russia by six notches on Tuesday evening to “C,” citing both domestic measures and foreign sanctions introduced in response to the country’s invasion of Ukraine as making a bond default “imminent”. Other global rating agencies including Moody’s and S&P have also lowered their ratings for Russia in recent weeks, and a number of economists are reducing their growth forecasts for Europe.

Central Bank Focus

Aside from events in Ukraine, it is a big week for central bank meetings this week, including the Federal Reserve (Fed), Bank of England (BoE) and the Bank of Japan to come this week. Last week, the European Central Bank (ECB) surprised the market somewhat with a more hawkish tilt on Thursday. Notably, it dropped the tone implying rates could go lower than current levels and on also pointed to a faster wind down of the Asset purchase Programme, which is now likely to end in the third quarter (vs. expectations of the fourth quarter previously). Unsurprisingly, the ECB cut its growth forecast for 2022 (3.7% vs. 4.2% previously), and hiked its inflation forecast (5.1% vs. 3.2% previously). The market is currently pricing in one rate hike by the end of 2022 now.

Looking to the week ahead, the market expects both the Fed and the BoE to raise rates by 25 bps. The uncertainty created by the Ukraine crisis has made the chances of a 50 bps rate hike from the Fed a lot less likely, as alluded to by Fed Chair Jerome Powell in recent weeks. However, inflationary pressures are clear, with US Consumer Price Index (CPI) printing at 7.9% (a 40-year high), so the market does still expect six rate hikes by year end.

Week in Review

Europe

As discussed, investor focus in Europe has been on the crisis in Ukraine and the  recent ECB meeting. As noted, the STOXX Europe 600 Index saw its first weekly gain in four weeks, and Spain’s IBEX rose 5%, while Germany’s DAX rose 5%. Looking at sectors, banks, travel & leisure were strong, while autos lagged.

Italian macro data gives us a good insight into some of the challenges Europe faces, with last week’s January Industrial Production slumping 3.4%. Italian producer price index (PPI) data showed a gain of 12.6% for January and up 41.8% year-over-year.

United States

US equities mirrored the recent weakness in Europe last week, closing the week down nearly 3%. The violence in Ukraine and the subsequent geopolitical tensions continued to be the key focus for investors, as Western governments discussed imposing further sanctions on Russia. Credit markets were also closely watched as an indicator of stock market performance, with US real yields back at the lows, which should make equities appear more attractive. Despite that, in terms of sectors, energy stocks managed to gain last week, despite a dip in oil prices. All other sectors finished lower.

The latest US CPI report showed that inflation was at a 40-year high in February. The report was in line with expectations at +7.9% year-over-year. As expected, energy prices were strong given the recent rises in oil and gas prices. This had a knock-on effect to grocery inflation, rising 1.4%, its strongest increase in four decades. Transportation, rent growth and service inflation all contributed to the strong print. Inflation does appear to be levelling off in the auto sector; however, the sector still faces a number of supply-chain headwinds near term. Whilst the market will remain at the mercy of the next headline on Ukraine, investor attention in the United States will shift this week towards the latest Fed meeting.

On the energy front, the Biden administration is reportedly open to easing sanctions on Venezuela in exchange for a ramp-up in oil exports. This came after the United States had banned imports of Russian oil. The White House defined that as a “significant action with widespread bipartisan support that will further deprive President Putin of the economic resources he uses to fund his needless war of choice.” The statement also said that the United States did not expect nor require European allies to take the same step and added that the United States was only in a position to do so because of its “strong domestic energy production and infrastructure.”

The White House announced that 90 million barrels would be released from the US Strategic Petroleum Reserve in order to keep energy prices down for Americans. Also, US Energy Secretary Jennifer Granholm told oil executives in Houston on Wednesday that the United States was now on a “war footing” and called on them to increase oil production immediately in a collective effort to avert a price spike.

The CNN Fear & Greed Index remains in “Extreme Fear” territory, indicating the extent of investor angst, but also the risk of a sharp move higher on any positive headlines.

Asia-Pacific

Last week was poor across Asia, with the MSCI Asia Pacific closing down 4.05%, dominated mainly by concerns over the Russia-Ukraine conflict and increasing COVID cases leading to restrictions across the region. We note that a new coronavirus variant that fuses elements of Delta & Omicron was identified last week. There were US threats of reprisals against Chinese firms found defying Russian sanctions and Norway’s sovereign wealth fund sold down some of its Chinese positions. In addition, surging commodity prices and worsening inflationary pressures are putting central banks in a situation of needing to tighten policy without choking growth. Risk of a consumer spending pullback amid escalating cost of living are driving concerns about stagflation as flattening yield curves and falling equity markets signal potential trouble for the global economy.

The markets got off to a poor start last week, with the prospect of a Russian oil embargo hitting risk assets especially and driving big gains in crude oil and metals prices.

Hong Kong’s equity market was the standout underperformer, closing the week down about 6%. Once again, COVID-19 is having a big impact as Hong Kong’s plan to test the entire population for coronavirus in March has been indefinitely postponed as the city prioritises vaccinating the elderly and reducing fatalities, according to Chief Executive Carrie Lam.

China’s mainland equities closed last week down 4%. On Monday, the government unveiled GDP growth of around 5.5% for 2022, above economist expectations. However, China reported the most new COVID-19 cases since the initial Wuhan outbreak and Premier Li reiterated the “Zero COVID” policy will stay but will be fine-tuned to minimise economic disruptions. China is increasingly seen as a part of the nexus with the United States threatening repercussions for Chinese companies defying export restrictions to Russia. Beijing appears to be standing with Russia amid reports it is weighing stakes in Russian commodity firms. China also warned the United States against forming a Pacific version of NATO, reiterating at the National People’s Congress that it remains committed to resolving the Taiwan question.

On Thursday of last week, South Korea’s presidential election saw opposition candidate Yoon from the People Power Party winning with the narrowest margin in history. Yoon is known for promoting more cooperation with US and sanctions against Russia and North Korea.

The Week Ahead

Events in Ukraine will continue to be a key driver for investor sentiment, with markets likely to see-saw on any meaningful news. Hopes for progress from talks seems to have faded after a burst of optimism on Wednesday saw markets squeeze higher. That said, it is a busy week for central banks too, with the Fed policy meeting on Wednesday and BoE on Thursday.  The market is pricing a 25 bps interest-hike for both. Note the BoJ also meets on Friday.

Calendar of Events

Monday, 14 March:

  • US State employment

Tuesday, 15 March:

  • UK Claimant Count & ILO Unemployment Rate
  • France CPI
  • Eurozone Industrial Production
  • US Core PPI
  • RBA Meeting Minutes
  • Chinese Industrial Production

Wednesday, 16 March:

  • Italy CPI
  • US Import prices & retail sales
  • Federal Open Market Committee meeting and statement
  • Japanese IP

Thursday, 17 March:

  • Eurozone EU27 New Car Registrations
  • Eurozone CPI
  • UK Bank of England policy meeting
  • US Jobless claims
  • US Industrial & Manufacturing production

Friday, 18 March:

  • Eurozone Trade Balance
  • BoJ Policy Meeting

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This article reflects the analysis and opinions of Franklin Templeton’s European Trading Desk as of 14 March 2022, and may vary from the analysis and opinions of other investment teams, platforms, portfolio managers or strategies at Franklin Templeton. Because market and economic conditions are often subject to rapid change, the analysis and opinions provided may change without notice. An assessment of a particular country, market, region, security, investment or strategy is not intended as an investment recommendation, nor does it constitute investment advice. Statements of fact are from sources considered reliable, but no representation or warranty is made as to their completeness or accuracy. This article does not provide a complete analysis of every material fact regarding any country, region, market, industry or security. Nothing in this document may be relied upon as investment advice or an investment recommendation. The companies named herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. Data from third-party sources may have been used in the preparation of this material and Franklin Templeton (“FT”) has not independently verified, validated or audited such data. FT accepts no liability whatsoever for any loss arising from use of this information and reliance upon the comments, opinions and analyses in the material is at the sole discretion of the user. Products, services and information may not be available in all jurisdictions and are offered by FT affiliates and/or their distributors as local laws and regulations permit. Please consult your own professional adviser for further information on availability of products and services in your jurisdiction. 

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MeDirect Disclaimers:

This information has been accurately reproduced, as received from Franklin Templeton Investment Management Limited (FTIML). No information has been omitted which would render the reproduced information inaccurate or misleading. This information is being distributed by MeDirect Bank (Malta) plc to its customers. The information contained in this document is for general information purposes only and is not intended to provide legal or other professional advice nor does it commit MeDirect Bank (Malta) plc to any obligation whatsoever. The information available in this document is not intended to be a suggestion, recommendation or solicitation to buy, hold or sell, any securities and is not guaranteed as to accuracy or completeness.

The financial instruments discussed in the document may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed herein.

If you invest in this product you may lose some or all of the money you invest. The value of your investment may go down as well as up. A commission or sales fee may be charged at the time of the initial purchase for an investment. Any income you get from this investment may go down as well as up. This product may be affected by changes in currency exchange rate movements thereby affecting your investment return therefrom. The performance figures quoted refer to the past and past performance is not a guarantee of future performance or a reliable guide to future performance. Any decision to invest in a mutual fund should always be based upon the details contained in the Prospectus and Key Investor Information Document (KIID), which may be obtained from MeDirect Bank (Malta) plc.

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