The conflict in Ukraine will keep the markets volatile

The initial reaction in financial markets to Russia’s full-scale invasion of Ukraine was as expected, with growing risk aversion and a flight to safety.

This caused stock markets to fall, credit spreads to widen, bonds to rally and safe haven currencies such as the dollar, yen and Swiss franc to gain ground.

However, the first batch of sanctions announced by Western governments was not as severe as expected in terms of its economic and financial impacts, which are likely to become more apparent in the medium term. This caused initial moves in financial markets to reverse somewhat, although stock markets have come under renewed pressure with the announcement of new sanctions.

Meanwhile, the prices of many commodities have risen sharply due to concerns about supply disruptions, and Russia is a major player in some of these markets. In particular, oil has risen above $100 a barrel, and wholesale gas prices have risen even higher.

European Commission President Ursula von der Leyen speaks during a press release at the EU headquarters in Brussels on Sunday. The European Union’s top diplomat is proposing to start using EU money to buy arms, ammunition and other support for Ukraine in response to Russia’s invasion of its neighbor. Image: Stephanie Lecocq, Pool photo via AP

Uncertainty

The increased uncertainty regarding Ukraine is a factor that the markets will have to deal with in the coming weeks, so we can expect to see a continuation of the increased volatility that has been evident in recent days. It is difficult to know how the situation in Ukraine will develop.

The economic implications are pretty clear though, with even higher inflation on the cards in 2022.

The eurozone is more exposed than other larger economies, given its reliance on gas imports from Russia, although its exports to the region are relatively small.

Central banks must now weigh a new element in their monetary policy deliberations as they try to balance higher inflation as a result of the crisis with its negative impact on activity. They are unlikely to change their minds about the need for higher rates, but they will likely take a more cautious approach to policy changes.

It is hard to see the US Federal Reserve or the Bank of England raising rates by more than 25 basis points at their March meetings.

intact recovery

The ECB may not announce a big change in its planned downgrade or curtailment of its bond-buying program at its policy meeting next week. You are also likely to want to retain flexibility around monetary policy, so long-term guidance may be limited. In any case, there has been a recent tightening of financial conditions, giving central banks a bit more leeway. Markets still expect rates to hit around 2% in the UK and US next year and rise as high as 0.75% in the eurozone.

This likely reflects a view that the global economic recovery will remain intact and elevated inflationary pressures will still require a significant degree of rate tightening. Furthermore, this crisis is just beginning to unfold.

We expect markets to remain highly volatile, with risk aversion the dominant theme.

  • Oliver Mangan is chief economist at AIB

Add Comment