The recent crisis in Ukraine has caused a great deal of uncertainty in the economy and markets. To cut through the noise, we take a look at the three key questions we are hearing from investors.
Important note regarding economic sanctions. This research references country/ies which are generally the subject of comprehensive or selective sanctions programs administered or enforced by the U.S. Department of the Treasury’s Office of Foreign Assets Control (“OFAC”), the European Union and/or by other countries and multi-national bodies. Any references in this report to entities, debt or equity instruments, projects or persons that may be covered by such sanctions are strictly informational, and should not be read as recommending or advising as to any investment activities in relation to such entities, instruments or projects. Users of this report are solely responsible for ensuring that their investment activities in relation to any sanctioned country/ies are carried out in compliance with applicable sanctions.
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Welcome to Thoughts on the Market. I'm Michael Zezas, Head of Public Policy Research and Municipal Strategy for Morgan Stanley. Along with my colleagues, bring you a variety of perspectives, I'll be talking about the intersection between U.S. public policy and financial markets. It's Wednesday, March 2nd at 3pm in New York.
As an analyst focusing on the interaction between geopolitical events and financial markets, I'm accustomed to dealing with uncertainties evolving at a rapid pace. But even by those standards, nothing in my career compares to the events of the past two weeks: the Russian invasion of Ukraine and the sanctions response by the US, the UK and Europe. To help cut through the noise, here's answers to the three most frequently asked questions by our investor clients.
First, do sanctions mean higher energy costs? In the short term, the answer is likely yes. While sanctions on Russian banks currently permit payments for various energy commodities, there's still restrictions on, and disruptions to, their transportation. With Russia being a key producer of several commodities, including 10% of the world's oil, it's not surprising that global oil inventories have declined and the price of a barrel of oil is sitting above $100.
This dovetails with the second question. Should we expect the Fed will shy away from hiking rates? In short, we don't think so, at least at the Fed's March meeting, but it certainly creates substantial uncertainty in the outlook. This conflict seems to be affecting both parts of the Fed's dual mandate in opposite directions. It risks dampening economic growth, but for the reasons we just described, it can also boost inflation. Accounting for both, our economists still expect the Fed to hike 0.25% in March but the conflict adds another layer to an already unprecedented level of complexity for the Fed. This is actually the key point for fixed income markets, in our view, where investors should prepare for ongoing volatility in Treasury and credit markets as the Fed may have to regularly tinker with their own assessment of growth and inflation.
Finally, what are the long-term implications for investors? To answer this question, we refer you back to our framework for 'Slowbalization,' or the idea that companies will have to, in certain industries, spend more to adjust supply chains and exit certain businesses as governments create policies that prioritize economic and national security over short term profits. You can see how this trend may already be accelerating after the onset of the Ukraine crisis, with several multinational companies announcing they'll sell stakes in, exit joint projects with or pause sales to Russian companies. But some equity sectors may see upside. Defense and software, for example, could see bigger spending as governments reorient their budgets towards these efforts, most notably Germany announcing it will boost its defense spending to 2% of GDP.
Of course, the situation remains fluid, and we'll continue to track it and keep you in the loop on what it means for the economy and markets.
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