Market Recap

Posted on March 4, 2022 by Gemmer Asset

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I’m not sure where you start with a weekly letter like this. The news out of Ukraine is heartbreaking and becomes more so as each day passes. The twists and turns in the financial markets pale in importance to the humanitarian crisis underway. If financial matters are the furthest thing from your mind this week, then this letter is worth skipping. End the week with the following thought – when you see humanity’s worst side is often when you see glimmers of our best. The fact that strangers driving to the Ukraine border to offer people help is one of the most uplifting things I’ve seen this week.


Massive Sanctions


From a market perspective, this week was all about sanctions, commodity supplies out of Russia and Ukraine, and what it means for prices. As widely reported, the raft of sanctions against Russia are hitting a number of areas, but the most notable one so far is the move against Russia’s foreign reserves. As The Economist notes:


‘Instead, the really big step is to target the institution at the heart of Russia’s fortress economy, the central bank. It holds $630bn of foreign reserves, equivalent to 38% of Russia’s GDP in 2021). Officials in the Biden administration say that they, acting with Europe, will prevent the central bank from using these reserves to undermine the impact of sanctions. As part of the fortress strategy Russia has shifted the composition of its reserves away from dollars: as of June 2021, it held only 16% in greenbacks, versus 32% in euros, 22% in gold and 13% in Chinese yuan. However, it is likely that the majority of its holdings of securities, bank deposits and other instruments, regardless of the currency they are denominated in, are held in accounts with financial institutions or in jurisdictions that will enforce Western sanctions. That means some, or even much, of Russia’s national war chest can be frozen.’


This is clearly a big deal and something we have only seen done before with Iran and North Korea. There are also a lot of other measures being taken – banning Russian flights through European airspace, limiting Russian banks’ access to the SWIFT interbank messaging system, impounding boats, etc. — but this is the most dramatic. Now no U.S., U.K. or EU institution can transact with the Russian central bank, and by extension, any Russian corporation.


The obvious consequence is a massive bank run on Russian assets to get out of the country as quickly as possible. Hence, Russia put on capital controls and hiked interest rates to entice locals to keep their money in the domestic banks. The central bank boosted its main interest rate to 20% from 9.5% in an emergency decision, saying that “external conditions for the Russian economy have drastically changed”.



Of course, this won’t make a difference. There were widespread reports of Russians converting rubles into anything tangible – iPhones, TV, furniture, anything – to try and preserve purchasing power due to the plummeting value of the currency. By week’s end the ruble was trading at roughly 123 to the dollar (the chart below is a couple days old, hence the stale quote).



That is assuming there were any dollars in Russia to convert to. Not easily done. Another knock-on consequence is that all publicly traded Russian bonds and equities are headed to zero, at least in the overseas markets. Russian Sberbank is down basically 99.8% YTD.



Grazprom is trading at $0 in London.



Commodity Shock


The consequences are not just financial, or course. There’s the impact that cutting off much of Russian and Ukrainian exports will have on the commodity markets. The table from J.P. Morgan below highlights Russia’s share of commodity production for various items.



And while energy exports haven’t officially been cut off yet, they are effectively shut down for a couple reasons. First, no commodity trader wants to touch Russian oil or gas at this point, and no bank is going to finance the trade. Furthermore, Russia is shutting off most of the Black Sea ports to trade. Combine this with the fact that insurance companies will no longer insure shipping in the Black Sea, and nothing is leaving the region anytime soon. As a result, commodity prices had their biggest weekly gain in 60 years.



Of course, we are seeing this locally in petrol prices – up at least $0.40 a gallon in the last couple days alone.



Economic Impact


What’s the economic impact? It almost certainly depends on where you are. As we noted in our communication a few days ago, it appears Europe is in a much worse position than the U.S. at the moment. They are at risk of losing access to energy supplies in the next few weeks regardless of price. This will have a major economic impact if it proves to the be the case. They also start from a position of relative weakness versus the U.S. economy. Those emerging markets that are commodity importers are also at risk, as are those that import lots of Russian or Ukrainian wheat (Egypt tops this list).


Domestically, the oil shock will certainly have an impact, but possibly less than it has in the past. The blue line below shows the spending in the U.S. on energy (largely gasoline) as a percent of income. It’s significantly below where it was even in 2007/2008 during the last spike in oil prices. This doesn’t mean high gasoline prices won’t weigh on the economy, but it does argue that they won’t crush growth in the U.S. just yet.



The consumer is also reasonably well positioned to withstand the price shock. Friday’s jobs report was largely ignored, but the report was solid. There were almost 700K jobs added last month and the unemployment rate hit a new cyclical low of just 3.8%.



Granted, this report was taken before hostilities started in Ukraine. But there is plenty of scope for further job and wage gains given the tight labor market. It is notable that there are 4.7 million more job openings than actual unemployed people at the moment.



But only time will tell if the relatively robust position of the U.S. consumer is enough to offset the mounting headwinds from higher commodity prices.


Charts We Found Interesting


1. The NYT COVID dashboard.



2. There isn’t just a shortage of homes to buy, there’s a shortage of rentals as well.



3. Which countries are most reliant on Russian gas?



4. A recipe for higher prices.



5. This secular decline has probably come to an end.



6. At least something is going down in value – used car prices come off the boil.




Have a good weekend.




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