There are decades where nothing happens, and there are weeks where decades happen. We are certainly now living through a period where history is being made.
Europe’s post-Cold War political and economic consensus is changing rapidly in response to Russia’s invasion of Ukraine. It took Germany just 4 days to reverse 30 years of geo-political policy, now committed to a €100 billion investment in its military and a diversification of energy supplies away from reliance on Russia.
As the war in Ukraine drags on, volatility continues to spike, and markets lack direction, the obvious question for investors is: what are the implications for market participants?
Re-iterating our view made in previous newsletters, the immediate economic impact from lower aggregate demand in Ukraine and Russia is low for the global economy. Both are relative economic minnows and so lower demand in both countries has little global impact.
What does matter more is supply from both countries of raw materials. Commodity price inflation as a result of supply interruptions and Western re-sourcing from countries that are not Russia has already added some upward pressure to commodity prices. This could likely persist, further adding to pre-existing inflationary pressures on the global economy.
In energy markets, a shift away from Russian sources of energy (gas) is likely good news for LNG suppliers and commodity exporters more closely aligned with Europe and the US. It is also likely good news for renewables and the nuclear power supply chain. Defence companies too will see some boost in the medium term from higher defence budgets.
More broadly, we think the main takeaway so far is a confirmation of something quite profound for investors. The regime of low volatility, predictable markets, and steady state economics we lived through in the decade leading up to 2019 is over. In its place is a new regime of more unpredictability and potentially higher levels of inflation for longer. Investors, in our view, must focus on ‘all weather’ investment strategies, which offer exposure to sustainable growth in cash flows driven by structural themes which will continue to play out, whatever the direction of macro-economic or political news.
Fed Moves Markets
The Fed’s commentary on interest rate outlook last week confirmed that monetary policy would tighten in March, with Chairman Jerome Powell saying he considered a 25 basis point rate hike “appropriate”. Traders now see a 95% probability of a 25 basis point rate hike in the US this month.
This move was widely expected, as the Fed had been clear in earlier communications that inflation consistently above its long-term target of 2% and a strong labour market justified tightening.
Markets responded positively to this news, a concrete example of something we have reiterated over the last few weeks: geopolitical uncertainty and economic uncertainty do not, necessarily, go hand in hand.
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