Russian Invasion Continues Market Volatility

Ukrainian Flags

At the close of business on Friday, global equities declined on the week as investors continued to assess the risk of the conflict in Ukraine. The yield on the US 10-year note dropped this past week to 1.738 from 1.98% a week ago. The price of a barrel of West Texas Intermediate crude oil surged to $110.60 from $91.03 while volatility, as measured by the Cboe Volatility Index (VIX), rose to 31.98 from 27.8 a week ago.



With the humanitarian crisis resulting from Russia’s invasion of Ukraine growing, we wish to express our sincere concern and support for the people of Ukraine. Russia has been isolated from the global financial system. Sanctions imposed by western governments in response to the invasion took hold this week, including the planned cutoff of seven Russian banks from SWIFT, the communications system that facilitates global money transfers. Foreign currency reserves held by the Central Bank of Russia have been frozen, limiting its ability to support a weakening ruble.

We estimate that 630 billion in Russian reserves is now frozen. Putin said on the weekend that the sanctions were a declaration of war against Russia, so it is clear the sanctions are already having an effect. MSCI and FTSE Russell announced on Wednesday that they will remove Russian equities from all their indices, effective next week. MSCI is changing its classification of Russia from an emerging market to a standalone market. According to Reuters, the country had a weighting of just over 3% in the MSCI emerging market index and about 0.3% of its global benchmark. S&P, after the second downgrade in a week, rates the country just two notches above default. The agencies said western sanctions call into question Russia’s ability to service its debt.

The VIX hitting above 30 once again historically has meant very strong equity performance twelve months later. Our strategic asset allocation has not changed. We believe equities will continue to outperform bonds over this year. As noted in earlier blogs, companies with no earnings, lofty future growth expectations, and high debt are being hammered in the market while companies with strong earnings, low debt, and reasonable earnings expectations are expected to lead the markets higher as this year progresses.



Canada is a major exporter of commodities and since the start of the Russian invasion, the broad Goldman Sachs Commodity Index is up about 16%, to a 14-year high. Oil futures breached $115 a barrel this past week for the first time since 2008 as sanctions limited market access to Russian raw materials. Russia has been forced to offer steep discounts on its crude but is still having trouble finding buyers. To the extent that dollar-denominated export revenues become unusable or illiquid, Russia could see less of an incentive to sell energy to the West. Oil prices eased from their highs on Thursday amid reports that western nations are close to a deal with Iran over its nuclear program. Wheat is up 8.7%, Corn 5.3%. Our central bank began its tightening cycle on Wednesday, raising its policy rate to 0.5% from 0.25%. We expect to continue to see three more quarter-point increases as this year progresses.



Powell signals the Fed will hike rates a quarter-point in the federal funds target when the FOMC meets March 15 and 16. Like Canada, we expect we will see rates in the US also increase by 1% by the fall of this year. Even with these expected rate increases, we will remain with historically low interest rates.



Germany and others undertake major policy shifts in defence and energy

The German government’s announcement that it will dramatically increase defence spending in response to national security threats posed by Russia is expected to help offset some of the economic drag stemming from higher energy prices. Shortly after the Russian invasion, German Chancellor Olaf Scholz laid out several major policy shifts, including halting the approval of the Nord Stream 2 gas pipeline from Russia while announcing the construction of two terminals to allow for the importation of liquified natural gas. Scholz also announced Germany will build a strategic natural gas reserve to reduce the country’s reliance on Russian gas supplies. In addition, the German chancellor floated the once-heretical idea of extending the life of several coal- and nuclear-fired power plants.

Germany is not alone in reacting strongly to Russia’s attack on Ukraine. Switzerland broke with its centuries-old policy of neutrality, sanctioning Russia, while Sweden and Finland are considering joining NATO. Sweden parted ways with tradition by exporting 5,000 antitank weapons to Ukraine, an active combat zone, this week. Meanwhile, Ukraine has applied to the European Union for immediate membership.

Despite Eurozone inflation soaring to a record 5.8% in February, markets have lowered expectations for multiple rate hikes from the European Central Bank this year. Fears of slower economic growth because of surging energy prices and the fallout from sanctions on Russia, combined to push the yield on the benchmark 10-year German bund back into negative territory this week. Bund yields peaked at 0.33% in mid-February, prior to Russia’s attack, in anticipation of tighter ECB policy.


China has not evacuated its citizens from Ukraine, but they have told their people not to reveal their nationality. China has urged Putin to resolve issues with Ukraine through negotiations and has told Putin that they are extremely concerned about the damage to civilians. We believe China, like the rest of the world, was caught off-guard by the scale and ferocity of the Russian offensive and the international response. We believe Putin clearly miscalculated when he started this invasion. Now he desperately needs support from the only place left. As China’s economy is slowing and it needs to support its own agenda, we see them as being an unwilling partner for Russia as this war continues. Growing Russian dependence on them may become a large liability from which China wants to distance itself.

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