How is the Russia-Ukraine war impacting Europe’s economy?

On the latest edition of Market Week in Review, Equity Portfolio Manager Olga Bezrokov and Research Analyst Laura Bardewyck discussed the status of the war in Ukraine and the partial reopening of Russia’s stock market. They also reviewed the latest economic data releases from Europe as well as market reaction to U.S. Federal Reserve (Fed) Chairman Jerome Powell’s recent comments on inflation.

Key developments from the war in Ukraine

With the Russia-Ukraine war now entering its second month, Bezrokov said that both the situation on the ground and the impacts to global markets and economies remain very fluid. U.S. President Joe Biden is currently meeting with NATO (North Atlantic Treaty Organization) and G7 (Group of Seven) leaders in Brussels to discuss further sanctions on Russia, she noted, adding that both the UK and U.S. announced additional sanctions on 24 March.

Bezrokov said that in retaliation for existing sanctions, Russian President Vladimir Putin is demanding that gas purchases made by what he calls unfriendly countries be paid for in rubles. "By announcing this, Putin is using Europe’s reliance on Russian energy markets as a way to exert pressure on European nations," she said, explaining that over 40% of natural gas used by European Union countries comes from Russia. Putin’s demands are also part of an effort to support Russia’s currency, which has plunged dramatically in the wake of Western sanctions, Bezrokov added.

She noted that the Russian stock market partially reopened on 24 March after enduring a month-long shutdown following the country’s invasion of Ukraine, with trading allowed in 33 of the 50 companies listed on the Moscow Exchange. However, the trading occurred with several limitations, Bezrokov said, including a ban on short selling as well as earlier restrictions that prevent foreign investors from exiting their shares. In addition, Russia indicated that a sovereign wealth-fund will step in to purchase local equities, she stated, explaining that this essentially amounts to a promise by the Kremlin to prop up the market.

"Ultimately, while there is now an indication of trading in the local market in Russia, the current restrictions mean that foreign investors-who account for the majority of the market’s free float-are absent. This means there is no official price discovery, which makes the market not a properly functioning market at this time," Bezrokov remarked.

Consumer confidence falls sharply in Europe as Russia-Ukraine war continues

Shifting to how the war in Ukraine is impacting Europe, Bezrokov said that a slew of economic data was released the week of 24 March, with the results fairly mixed. One disappointing reading came from the European Commission’s survey on consumer sentiment, she noted, which showed that eurozone consumer confidence plummeted in March, falling by 9.9 points to a reading of -18.7. "Markets had been anticipating a reading of -12.9, so this number was even worse than expected," Bezrokov said, adding that the survey shows the war in Ukraine is clearly weighing on sentiment.  

On a more optimistic note, recently released March PMI (purchasing managers’ index) numbers for European manufacturing all came in above expectations, she remarked. In addition, while readings from the eurozone, France, Germany and the UK were pretty mixed-with some numbers decreasing and some marginally increasing from prior levels-they all registered above a level of 50, indicating expansionary conditions, Bezrokov said. "All in all, this was a reasonably good outcome for European economies," she stated.

Meanwhile, the latest numbers on inflation showed that pricing pressures remain elevated, she said, with UK inflation hitting a 30-year high of 6.2%-on a year-over-year basis-in February. "This was higher than the market forecast of 5.9%, and led UK Chancellor Rishi Sunak to unveil a slight easing of fiscal policy in his spring statement," she explained.

Undeniably hawkish: Powell doubles down on rate hikes

Turning to inflation in the U.S., which is also running at multi-decade highs, Bezrokov said that Fed Chair Jerome Powell reiterated the central bank’s concerns over elevated inflation in recent remarks at the National Association for Business Economics conference. At a 15-16 March policy meeting, Fed officials had indicated they were increasingly worried about broadening inflationary pressures, and Powell doubled down on that message in his 21 March speech, she noted.

"The tone of Powell’s speech was undeniably hawkish, with the Fed chair making it abundantly clear that the central bank is prepared to continue raising rates, even if it means slowing down the U.S. economy," Bezrokov stated. Powell also indicated that the Fed is prepared to raise rates by 50 basis points at its next meeting, should it prove necessary, she said.

Bezrokov noted that equity markets initially sold off in the wake of the Fed chair’s comments, but said that, as of 24 March at midday Pacific time, they’d mostly recovered their losses. The rout in U.S. Treasuries, however, has only deepened in recent days, she observed, with the yield on the benchmark 10-year note rising to near 2.4%.

So, what are the potential implications of all this for investors going forward? Bezrokov said it’s important to understand that markets have already been pricing in a significant amount of rate hikes for 2022, noting that the risk of higher rates has likely been a catalyst behind some of the volatility and declines in markets so far this year.

"Ultimately, in my view, this suggests that much of the impact of higher rates is now baked in-and that equities are likely to be in more of a digestion phase moving forward," she concluded.

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