Energy prices have dominated markets this week together with the potential knock-on impact they could have on economic growth. Brent crude oil spiked to $139 a barrel as the US banned the import of Russian oil and the UK agreed to phase it out by the end of the year. Russian oil accounts for about 3% of US oil and 8% for the UK. On the news of the US corralling western allies to follow their lead, European natural gas futures touched €335 a megawatt-hour, a 35% increase on last Friday’s price. One year ago, the contract was trading close to €18. However, by midweek energy prices started to subside as the European Union abstained from the ban, where Russian oil accounts for a massive 27% of their total imports. It was also reported that the United Arab Emirates moved to encourage other OPEC members to increase production. On Wednesday, Brent crude fell to $110 at its lowest point and European natural gas futures dropped beneath €150. This set off a strong relief rally in European equities, with the Eurostoxx 50 rising by over 7% on Wednesday, having previously fallen by 20% year to date, pricing in a mild recession.
As of 12pm on Friday, London time, European equities rose 3.2% over the week, whilst UK stocks increased by 3.5%. The US market also rallied midweek but was still recording a loss of 1.6% at the close on Thursday, whilst US technology stocks were down 1.4%. Despite the advent of the Ukraine war, expectations remain high that the US Federal Reserve (Fed) will stick to its interest rate hiking cycle whilst inflation continues to rise, and US growth remains robust. Japanese equities were down by 2.5%, Australian equities fell 0.7%, whilst the emerging markets dropped 3.7%, with China losing 4% and, offshore, Hong Kong stocks dropping 6.2%.
It was not only energy prices that saw massive swings, as any commodity where Russia is a key player experienced extreme price volatility. The price of nickel, of which Russia represents 10% of the globe’s supply, surged on Monday, closing 66% higher at $48,033 a tonne as short-sellers looked to unwind their positions. When the market reopened on Tuesday, the price went above $100,000, meaning that several of the trading companies on the London Metal Exchange (LME) would not have been able to meet their margin calls. To the disgust of many, the LME subsequently closed all trading in Nickel for the week and cancelled all contracts from the end of Monday. A Chinese businessman linked to the world’s largest nickel producer, Tsingshan Holding Group, is thought to have been behind the short selling.
The latest US inflation data was released on Thursday, with headline consumer price inflation coming in at 7.9%, the highest level in forty years. This reinforced the view that the Fed will continue to raise rates despite the Ukrainian war. On Friday, Goldman Sachs downgraded US economic growth to 1.75% from 2%. Whilst the European Central Bank (ECB) is still forecasting economic growth of 3.7% for 2022 in the EU due to reopening from the covid pandemic. The ECB on Thursday said that it would accelerate its exit from quantitative easing, lowering its monthly bond purchases to €20billion a month by June, brought forward from October, catching investors off guard.
US Treasuries resumed their sell-off, with the yield on the 10-year, which moves inversely to price, rising to 2.02%. Similarly, despite the massive uncertainty of war on their doorstep, German bond yields rose to 0.31%, and UK gilts to 1.55%. Although Gold, a haven asset often associated with crises, increased in value by 0.6% to $1, 978 an ounce despite rising bond yields which would ordinarily take the shine off the precious metal.
The market is chiefly concerned with an escalation of the war outside of Ukraine itself, or a substantial increase in energy prices that turns energy from an inflationary force into a deflationary force as demand falls away and recessionary risks increase. Back in 2008 this occurred at a price level of around $150 a barrel for oil, and today it is estimated anywhere between $150 to $180.
However, despite all the uncertainties created by the war, that is not where we are, or at least, not yet. Global growth is expected to continue as the world exits the covid pandemic. Even the ECB continues to forecast very robust growth.
With inflation running at record levels, that means, contrary to previous years, central banks are unlikely to come to the rescue of markets in the near term. As the market increasingly becomes accustomed to the war, and as long as it does not escalate, cheaper, more economically sensitive stocks are likely to resume their recent dominance over more expensive growth stocks, whose earnings potential are priced further into the future.
However, we cannot discount an escalation in the war, at least economically, especially whilst it looks difficult for President Putin to extricate himself from a much weaker position than he undoubtedly thought he would be in. The threat of Russia weaponising the natural gas supply to Europe looks real.
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