All eyes continue to be squarely focused on the military conflict in the Ukraine. Not surprisingly, stock market volatility remains elevated. Yet, some equity markets outside of Europe are actually higher than where they stood prior to the recent escalation. This outcome may seem unusual, but it is similar to other major military conflicts through history where global markets priced in the risks before the start of a war, only to witness some price stabilization shortly after the fighting began. Nevertheless, the situation is fluid, and it is important to remain vigilant.
Our firm’s global investments team has produced the attached update on the Ukraine/Russia crisis, with a particular focus on the impact to the European economy and implications for the region’s investment outlook. Most interesting was the discussion related to Europe’s dependency on Russia for its energy needs and the region’s decarbonization efforts, and the transformations taking place within the region that could result in a more unified European Union going forward. We believe this recent piece is a worthwhile read.
The report also focuses on the central banks, whose roles have become more complicated. Over the past week, the Bank of Canada raised interest rates by 25 basis points, as was largely expected. The U.S. Federal Reserve remains poised to raise interest rates by the same amount when it meets next. While both central banks are expected to hike rates further through the year, the outlook on the exact path of rate increases looks increasingly murky.
Elevated inflation was a headwind entering this year, but was expected to moderate to some extent as the year wears on. Any relief is now in jeopardy because of the war and its impact on supply chains, and in particular the commodity complex. Russia and the Ukraine are important producers of a variety of commodities. Crude oil, natural gas, coal, wheat, corn, sunflower oil, palladium, nickel and aluminum are some of the commodities whose prices have moved higher. Barring any quick resolution to the war, these prices may remain elevated and keep inflation higher for longer.
Corporations and consumers in the U.S. have some capacity to handle higher costs, given strong balance sheets, benefits from the economic reopening and elevated levels of disposable income. If, however, price pressures mount further or stay elevated for an extended period of time, they will produce a drag on global growth. Central banks, which were predominantly focused on inflation to start the year, are now contending with the uncertain negative economic consequences posed by an unpredictable conflict between the Ukraine and Russia.
The new state of global affairs may lead central banks to approach their rate hiking campaigns more gradually than originally planned. A slower pace would undoubtedly be welcomed by investors, as long as the risks of recession remain relatively limited. For now, this is our base case scenario.
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