The conflict between Russia and Ukraine threatens to provoke a crisis of raw materials and an earthquake in the stock markets

The growing tension on the Russia-Ukraine border and the beginning of the end of monetary stimulus have hit almost all risk assets in recent days. That ‘almost everyone’ holds the key to what is happening and what may be to come in the economy and the markets. So far in 2022, oil and gas they have followed an opposite trend regarding stocks or cryptocurrencies. These two raw materials feel comfortable in the heat of geopolitical tensions, which gives clues about the scenario that can be created if there is a real conflict between Russia and Ukraine, with many others directly or indirectly involved.

This 2022 promised to be a year of turbulence for the markets due to the rapid arrival of the monetary ‘hawks’. What was not counted on, at least with such certainty, was a conflict that could directly or indirectly involve so many countries.

In an adverse scenario, a clash between Russia and Ukraine with the West as an indirect party oil price can skyrocket, gas and other raw materials, adding fuel to the fire of inflation and putting central banks in an even more complicated situation: tightening monetary policy in the midst of a conflict can be fatal for the markets, while not doing so can be reckless with inflation at historically high levels.

“In a scenario where the West reacts strongly with sanctions targeting key Russian industries, this could have a far-reaching impact on the commodity complex. It would affect more than just commodity flows passing through Ukraine or originating from it. It could lead to significant tightening in energy, metals and agricultural markets, adding further impetus to an asset class that already has plenty of positive sentiment,” said Warren Patterson, chief commodity strategist. of ING.

An oil shock

JP Morgan analysts have published a note evaluating the impact on the economy of a conflict between Russia and Ukraine. In this scenario, they foresee that the oil production that Russia produces could be reduced by 2.3 million barrels per day (either due to inability or political decision to exert pressure), which would trigger the price of oil. oil up to 150 dollars per barrel in the short term. It should be remembered that Russia produces 10.8 million barrels per day. The oil shock alone could cut global growth by 1.6 points in the first half of 2022 and push inflation up to 7.2% (vs. 3.2% forecast).

In addition, JP Morgan analysts warn in this weekly report that “oil supply shocks they have a long history of triggering recessions in the US, often linked to the spike in oil prices. Precisely, the latest geopolitical tensions between Russia and Ukraine increase the risk of a material rise this quarter in the price of crude oil. The fact that this is coming with already high inflation, which hit a multi-decade high last quarter, and a global economy that is being hit by another wave of the covid-19 pandemic, adds a notch to the short-term fragility facing the recovery”.

The power of Russian gas

The point is that it’s not just oil, Russia is a great producer of raw materials that are voraciously consumed by the rest of the world, including Europe. In another report from the same bank, the difficult situation facing the Old Continent is highlighted: Russia is the second largest producer of natural gas worldwide and represented 17% of the total supply of natural gas in 2020. In addition, Russia exports the 37% of the national production that goes mainly to Europe.

In this situation, the sanctions related to energy would be the ones that would affect Europe the most. “The region is already dealing with an extremely tight gas balance. Therefore, any further reduction in Russian gas flows to the region would leave the European market vulnerable… The flows come via various pipelines via Ukraine, the Yamal-Europe pipeline via Belarus, the Nord Stream pipeline and the TurkStream,” says ING’s Patterson, citing all the tensions surrounding the Nord Stream 2 pipeline. the region’s dependence on Russian gas and the current energy crisis”.

“Any long-term interruption in Russian pipeline exports to Europe will put the full weight of the summer storage flow directly into the LNG (the gas that arrives through the ships) and it could cause another price rebound in European natural gas similar to the one observed at the end of December, when the price was established above 180 EUR/Mwh”, they assure from JP Morgan.

The metals market could also be affected with reminiscences of what happened in 2018 with aluminum. The sanctions outlined by the US contemplate that the president could identify and impose sanctions on industries that he considers to pose a risk to national security, which includes the extraction and processing of minerals. “You don’t have to go back too far to see the impact that sanctions on Russian aluminum producer Rusal had on the global aluminum market. US sanctions against Russia rocked the aluminum market in 2018with Russia being the largest producer of aluminum after China,” says Patterson.

“The world aluminum market is in deficit at the moment, so any interruption of these flows would only push the market into a greater deficit. Since Europe is an important destination for Russian aluminum, a measure that restricts the flows of aluminum would be bullish for European premiums,” recalls the analyst. “The sanctions could also affect the production of European aluminum smelters. As we are seeing, smelting capacity in Europe is having to close due to high energy prices,” he adds. The risks could extend to metals such as nickel, copper, palladium and platinum., of which Russia is a major producer.

Another flank that may be shaken is that of soft commodities. In recent years, Russia has climbed the ranks to become the largest exporter of wheat of the world. “There is no mention of the food and agriculture industry in the proposed US sanctions package. However, sanctions against financial institutions could make trade more difficult. Therefore, harsh sanctions could have an impact on agricultural exports, even if they’re not specifically sanctioned,” Patterson says.

for now, Wheat futures have bounced sharply in previous sessions. “Technically, the future of wheat is trading above 800 dollars, after registering a rise in 2022 above 7%, with an eye on exceeding the highs of last December,” says Diego Morin, IG analyst.

What will the ECB do with inflation?

With oil at $150 and natural gas soaring, the European Central Bank’s main asset (a drop in energy in 2022) to argue for moderation in inflation would blow up. Both gas and oil would present higher prices than during 2021 (their contribution to the CPI would be positive), to which should be added the impact of production costs that companies are gradually passing on to consumers.

Those in charge of monetary policy would find themselves in an even more complex situation. On the one hand, there are those who believe that the ECB would bet on making monetary policy even more flexible in an attempt to cushion the impact on the confidence of agents and on the markets.

From Berenberg they believe that “an additional increase in energy prices in the coming months would be the type of temporary supply shock that the ECB would have to analyze, although in principle it should not advance rate hikes. Instead, the ECB could even intervene by temporarily opening the taps again with more force to ensure that financial markets continue to transmit monetary stimulus to the real economy.

Central banking would have to deal with a stock market earthquake and an oil shock at the same time. Chris Iggo, CIO of Axa Investment Managers, assumes that in the face of a conflict “Equities would sink due to the risks for economic growth, and the dollar would soar against the euro because a war in the Ukraine would be a very immediate practical problem for Europe (refugees, even higher natural gas prices, the need for a united response by the nations of the EU). But things would get complicated very quickly in terms of how the West would respond, how brutal the conflict would become, if Belarus entered the fray and what financial and economic sanctions or actions would be taken by both sides.” It is this initial panic in markets and confidence that supports the central bank’s expansionary response to war.

But opening the taps more also has negative consequences, especially for inflation. JP Morgan analysts argue that “the reaction of central banks may cushion or exacerbate the impact of the conflict-induced commodity boom. For the past three decades, central banks in developed countries, led by the Fed, have have tended to see supply shocks that drive inflation as a drag on growth that needs to be cushioned. Hence, there is a tendency to think that even if inflation soars, the central banks would increase the expansionary tone of their policies to cushion the blow to confidence, consumption and investment.

“However, with inflation at high levels and political stances yet to normalize, there will be considerable concern related to ensuring that inflation expectations remain anchored close to the goals”, they warn from JP Morgan.