The recent unprovoked attacks on Ukraine have stunned and saddened us. While the U.S. and other nations coordinate to create enough economic pain in Russia to halt further aggression, too many deaths have already occurred. We mourn the loss of life, the displacement of hundreds of thousands of Ukrainians, and the fear that now cloaks their country. Last month, we thought that interest rate increases would consume investors’ attention for the foreseeable future. How fast things change.
After vacillating without a clear direction for the first half of February, stock and bond prices began falling with news of rising tensions in Eastern Europe. Curiously, based on closing prices, the day leading up to Russia’s invasion of Ukraine marked the year-to-date low point in both U.S. stocks and bonds, down 11.9% and 4.2% respectively. These same markets recovered some of their losses during the invasion. Still, the U.S. stock market fell 2.9% for the month, with the overall U.S. bond market declining about 1.1%. International stocks, both developed and emerging, fell about 2-3% as well. Despite the greater potential exposure to the conflict, international stocks are still holding up better than U.S. markets this year.
While we still don’t know the duration or the ultimate outcome of the Ukrainian invasion, the resolve of global governments to place severe sanctions on Russia has only grown. The disruptions to trade and financial flows caused by sanctions will likely increase inflation, but only at the margin. We do note, for example, that Treasury Inflation-Protected Securities rallied by 2-3% during the second half of February, and Brent and U.S. crude prices briefly topped $100 per barrel. Since the combined economy of Russia and Ukraine is only about 3% of global GDP, however, the direct effects of the conflict on the global economy should be limited. For example, one prominent investment bank estimates that a $10 per barrel increase in the price of oil would only translate to a 0.1% reduction in annual U.S. GDP.
Will the war in Ukraine impact the Federal Reserve’s plan to increase interest rates? We don’t think so. The potential for additional inflationary pressures, however slight, should keep the Fed’s tightening plan on track. Recent Fed officials’ statements align with our assessment. On March 16th, the Fed will conclude their interest rate setting meeting (FOMC) and are likely to increase short-term interest rates by a quarter of a percent. There’s a distant chance of a double hike to 0.50%, but the odds of that have faded sharply with the increase in global uncertainty. Markets are still expecting six quarter-point hikes by the end of 2022.
Russia’s invasion of Ukraine has had and will continue to have both a terrible humanitarian and economic cost for both countries, so a reminder of stock market history is relevant. While stock markets do not like uncertainty, they can be shockingly indifferent to human suffering. Russia’s 2008 invasion of Georgia and 2014 invasion of Crimea did not have an effect on the stock market. Here in the U.S., the stock market has produced positive returns during a pandemic that has ended over 900,000 lives. This history speaks to the importance of remaining consistent with your long-term investment strategy.
While the stock market is often unmoved by tragedy, we are not. As an organization that has spent so much of its existence striving toward the goal of “Making a good life happen”, this is a terrible blow to humanity. Like many of you, we hope for a peaceful resolution soon.