Positive macroeconomic news in early February was overshadowed by Russia’s invasion of Ukraine during the last week of the month. Markets were broadly lower, with real assets and commodities being the exception. Economic sanctions on Russia continue to pressure commodity prices and inflation globally which, paired with escalating uncertainty, will likely affect central bank positioning. As 2022 evolves, the themes of inflation and market volatility remain evident. We continue to expect moderation with the ongoing recovery, with a positive view of global growth and see a near-term recession as unlikely.
While February began with eyes on Fed Chairman Powell’s hawkish stance, inflation and a focus on the job market, the resounding theme was Russia’s invasion of Ukraine during the last week of the month. As this evolved from a low likelihood event to a distressing reality, markets adopted a risk-off stance.
Markets trended lower in February, further adding to January’s losses across most asset classes. Notably, crude prices added to recent gains driven by uncertainty regarding sanctions on Russia, a major crude exporter. This pushed oil toward $100/barrel, the highest level seen since 2014. Energy and real asset names benefited from this acceleration in the prices of oil and other commodities.
Although Russia is a major commodity supplier to the rest of the world, particularly Europe, its role in investment portfolios is muted. The drawdown in Russian equities led to a halving in its size in the MSCI Emerging Markets Index. Additionally, index providers such as MSCI began discussing the removal of Russian equities from indices, given ongoing market closures that made them entirely illiquid. This will boost the relative size and importance of other regions in indices. Of note are Brazil and Saudi Arabia, which have benefited from the rise in crude oil and commodity prices. Their roles have been further magnified by weakness in other emerging markets.
While geopolitics remain at the forefront of attention, the gears of the U.S. economy continue to churn. Despite the economic disruption wrought by the omicron variant, the job market showed strength, gaining 467,000 jobs in January, more than three times the forecast of 150,000. The bulk of these gains came from the services sector, which added 440,000 new jobs. Strength in consumer spending was another positive factor, as retail sales grew 3.8% in January, compared to a deceleration of -2.5% in December. Given the central role of consumers in the economy, this strength bodes well for continued recovery. Further evidence of economic strength was provided by the S&P 500 showing 30.7% earnings growth for the fourth quarter of 2021. The February CPI number of 7.9% is the highest it’s been in 40 years. Further prospects of high inflation will be a factor in the Fed’s rate decision in coming months, especially given uncertainty regarding Russia, elevated market volatility and recent trends in commodity prices.
Given the rapidly evolving nature of the situation in Ukraine, we continue to keep a keen eye on additional developments. Our thoughts are with those affected by this conflict and others around the world. Post Russia-Ukraine conflict, the key takeaways are the upside risk to inflation and Russia’s relatively muted role in investment portfolios. Although elevated oil and natural gas prices will further stoke inflation, the heightened risk arising from the conflict in Ukraine may give the Fed and other central banks grounds to temper their recently hawkish tone.
We continue to watch these key themes this year, namely, volatility and inflation, as well as policy makers walking a tightrope amidst an evolving landscape. Investing for the long-term in a volatile environment remains key, as well as sticking to investment goals and maintaining a well-diversified portfolio.
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