What the threat of a Russian invasion of Ukraine means for markets

Headline-driven volatility

Stocks and other financial markets continued to react to headlines over the past week, reflecting relief after Moscow, which denies its planning an invasion, said it was pulling back some troops from the Ukraine border. However, that relief proved short-lived as the U.S. and its allies said that instead of pulling back, Russia moved more troops forward, with Russian forces engaging in the sort of false-flag activities that the Biden administration said Moscow would likely use as a pretext for an invasion.

Read: Here’s the technology being used to watch Russian troops as Ukraine invasion fears linger

U.S. investors may have been reluctant to hold on to assets perceived as risky heading into a three-day holiday weekend. U.S. markets will be closed Monday for the Presidents Day holiday.

U.S. stocks suffered weekly losses for the second week in a row, with the Dow Jones Industrial Average DJIA, -0.68% falling 1.9%, the S&P 500 SPX, -0.72% losing 1.6% and the Nasdaq Composite COMP, -1.23% declining 1.8%. Treasury yields TMUBMUSD10Y, 1.927% fell as investors sought out assets viewed as havens during periods of geopolitical uncertainty and the desire for safety also lifted gold GC00, +0.05%.

Oil, however, failed to get a lift from Ukraine tensions, though invasion fears were credited the previous week for driving both the U.S. CL.1, +0.65% CL00, +0.38% and global BRN00, +0.07% benchmarks to seven-year highs not far below the $100-a-barrel threshold. Instead, prospects of a revived Iran nuclear accord, which could eventually lift U.S. sanctions on the country’s crude exports, prompted profit-taking as crude futures ended a streak of eight weekly gains.

Energy shock?

So what happens if an invasion of Ukraine takes place?

For investors, the focus would be on energy prices, with analysts warning that crude oil remains likely to shoot above $100 a barrel.

Biden has said U.S. troops won’t be deployed to Ukraine but has promised “severe” sanctions against Moscow in the event of an invasion.

“Biden remains adamant that Ukraine will be defended, and that sanctions such as blocking energy sales will be deployed as a counter to Russia’s militant action. With oil prices already at multiyear highs due to misaligned supply/demand dynamics, further tension could mean more upside potentially (north of $100) that could negatively impact both the U.S. and global economy,” said Larry Adam, chief investment officer for the Private Client Group at Raymond James, in a note.

“While we remain optimistic that a diplomatic resolution and/or de-escalation (base case) will ultimately result, this is not a certainty with tensions high. A favorable outcome would reduce the current geopolitical risk premium built into oil prices (at least $5-$10) and return oil closer to our year-end target of $80,” he wrote.

Beyond crude oil, Russia’s role as a key supplier of natural gas to Western Europe could send prices in the region soaring. Overall, spiking energy prices in Europe and around the world would be the most likely way a Russian invasion would stoke volatility across financial markets, analysts said.

Bread basket

Not everyone is convinced significant supply disruptions, particularly for crude oil, would be inevitable.

“We suspect that neither the West or Russia has much appetite for curtailing the trade in energy, and that prices could fall back fairly swiftly,” wrote commodities analysts at Capital Economics, in a note.

“By contrast, the West has sanctioned Russia’s metal producers before and, with most of Russia’s grain exports leaving from Black Sea ports, the risk of supply disruption there is high,” they said.

Indeed, analysts have warned that wheat prices W00, -0.56%, in particular, could see further gains in the event of an invasion. Both Russia and Ukraine are major exporters of the grain. Corn C00, +0.73% and soybean futures S00, +0.60% were also seen as likely to be lifted.

In depth: Why the Russia-Ukraine crisis may make food-price inflation even worse

Stocks and geopolitics

For the most part, equity analysts continue to play down the potential for an invasion to have more than a passing impact on U.S. equities.

Despite near-term volatility in the wake of geopolitical events over the past three decades, ranging from terrorist attacks to the start of wars, stocks have tended to bounce back relatively quickly, Adam noted, rallying 4.6% on average in the six months following such crises dating back to 1990 and rising 81% of the time.

“In general, Fed policy and economic conditions tend be the more long-term drivers of the economy and financial markets rather than isolated geopolitical events,” he said.

Still the economic and market ramifications of an invasion “may pose a near-term downside risk to the global economy and cause market volatility to persist,” he said.

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