What Are the Macro and Market Implications of the Russia-Ukraine Crisis?

The risks to global growth posed by the Russia-Ukraine conflict are materially altered by the launch of a full-scale invasion. So far, as of March 8, our global economics team has reduced global growth by 0.8%-pt and has added 0.9%-pt to inflation in 2022 with annualized inflation to remain above 6% in the first half of 2022. The magnitude of the shock and the nature of these reverberations remain highly sensitive to the uncertain path that the conflict travels but recent events are prompting downward revisions to growth and upward revisions to inflation forecasts, says Chief Economist Bruce Kasman.

The Russia-Ukraine crisis will slow global growth and raise inflation as global growth risk is linked to Russia energy supply disruption. J.P. Morgan Research continues to forecast a synchronized monetary policy tightening cycle due to healthy demand and rapidly tightening supply that points to continued inflationary pressures. Russia accounts for well over 10% of global oil and natural gas production. Curtailing Russian energy supplies following the invasion of Ukraine could produce a sharp contraction in its crude oil exports to Europe and the U.S. of 4.3 million barrels per day (mbd). Assuming the drag fell entirely in the first half of 2022, it would subtract 3% annualized from global GDP and add 4% annualized to the global consumer price index (CPI). According to J.P. Morgan’s Global Economics team, if this remains solely a negative supply shock and if the price of oil reaches $150, the hit to global GDP growth would be 1.6%-pt based on its general equilibrium model.

J.P. Morgan Global Research outlines initiatives under way to address the shortfall of a shut off in Russian oil exports:

1. On March 1, the United States and 30 other member countries, supported by the European Commission, agreed to collectively release an initial 60 million barrels of oil from strategic petroleum reserves, which could be increased further.
2. The International Energy Agency’s 10-Point Plan presented on March 3 aims to reduce the EU’s reliance on Russian natural gas and sets out measures that could be implemented within a year to reduce Russian natural gas products.
3. The European energy security policy released on March 8 includes steps to move away from Russian dependency on energy, focusing primarily on reducing dependency on the gas markets.
4. The prospects for a nuclear agreement with Iran are rising. J.P. Morgan Research forecasts a deal in which Iran ramps up oil production by close to 1 mbd over the course of the year.
5. A mild winter has reduced imbalances in the European natural gas market and inventories have increased.

The Russian economy is headed for a deep recession and the imposition of capital controls. While there is some room for Russia to use its gold reserve and divert trade to China, Russia’s financial system is set to come under enormous stress as it will struggle to meet its financing obligations despite running a current account surplus. Downward pressure on the ruble and capital flight have pushed the central bank of Russia to raise rates dramatically and impose capital controls. J.P. Morgan Research forecasts that Russia’s economy will contract 35% quarter-over-quarter and seasonally adjusted in the second quarter, and for the year experience a GDP contraction of at least 7%. Inflation could end the year at around 14%, up from 5.3% forecasted before the crisis, with risks skewed heavily to the upside due to ruble depreciation and import shortages.

Global Equities

The Russia-Ukraine crisis is a low earnings risk for U.S. corporates. However, an energy price shock amid a central bank pivot focused on inflation could further dampen investor sentiment.

Domestic Russian banks, followed by European banks with local legal entities in Russia, are the most exposed to risk resulting from sanctions.

U.S. companies have low direct exposure to Russia (around 0.6% for those in the Russell 1000 index) and Ukraine (<0.1%) based on disclosed revenues. Indirect risks could be more substantial, including:

• Slower global growth and consumer spending due to higher oil and food prices
• Negative second-order effects through Europe
• Supply chain distortions
• Credit and asset write-downs
• Cybersecurity risks
• Tightening monetary policy

Tightening monetary policy remains the key risk for equities as central banks grapple with inflation expectations. Policymakers may also consider additional fiscal stimulus such as a U.S. gas tax reduction.

Selected emerging market (EM) equities, particularly commodity exporters, should outperform amid a combination of higher rates and energy prices. Energy and materials, and Middle East and North Africa/Latin America would likely be the biggest beneficiaries, while healthcare and real estate stand to lose the most.

European miners should see higher commodity prices due to supply dislocation of Russia-centric commodities. Palladium is the most exposed commodity, with Russia accounting for around 45% of total global production – prices are up around 65% since mid-December 2021. Russia accounts for over 10% of global supply of diamonds, platinum and gold, while Russia and Ukraine combined account for in the region of 35% of EU-27 steel imports. 

Commodities

J.P. Morgan continues to expect an extended period of elevated geopolitical tensions and high-risk premium across all commodities with exposure to Russia.

Reflecting the higher risk premium and given the large supply shock, Natasha Kaneva, Head of Commodities Strategy, believes oil price will not only need to increase to $120 bbl but stay there for months to incentivize demand destruction, assuming there are no immediate Iranian volumes entering the market.

If Russia were to use oil exports to exert pressure on the West, 2.9 mbd of crude would be at risk, which translates to a $50 bbl annualized price impact. China remains the wild card in this scenario. The country could opt to buy 1 mbd more of Russian oil at a steep discount and store it, without making any adjustments to its market purchases. On the other hand, it could reduce market purchases commensurately, freeing up to 1 mbd of supply from other sources. However, if disruption to Russian volumes lasts throughout the year, Brent oil prices could exit the year at $185 bbl, likely leading to a significant 3 mbd drop in the global oil demand. Even if shale production responds to the price signal, it cannot grow by more than 1.4 mbd this year given labor and infrastructure constraints.

In natural gas, J.P. Morgan Commodities Strategy revised up their summer 2022 title transfer facility (TTF) price forecast to 77.50 euros ($85.95) per megawatt hour (EUR/MWh) to reflect the evolving geopolitical risks of the Russia-Ukraine conflict. This assumes that Russia would continue to honor long-term natural gas supply commitments to Europe, which could come into question, and removes the prospect of Nord Stream 2 commencing from our 2022 and 2023 forecast.

Gold prices received a boost from “safe haven” demand and falling real yields in the U.S. as risk-off trading has intensified. With U.S. 10-year real yields now back down below -100 basis points, gold spiked to above $2,000 per troy ounce — the highest level since August 2020. Prices are set to remain volatile. While this is not J.P. Morgan Research's base case, a continued push lower in real yields (whether from a more dovish Fed than expected or higher inflation breakevens being priced in on the back of the commodities rally, or a combination of the both) and additional boosted “safe haven” / inflation hedging demand for precious metals on the back of a continued melt-up in other commodities, particularly energy, could likely send gold prices up towards $2,200/oz.  

See J.P. Morgan Research’s latest energy forecasts and find out what’s next for oil and gas prices during the Russia-Ukraine crisis. 

Forex

The Russia-Ukraine conflict has initiated pockets of forex (FX) volatility with U.S. dollar (USD) / Russian ruble hitting all-time highs. Moves in the broader FX markets have been tame so far: the Japanese yen is likely to outperform with the USD, while Euro-area currencies are the most exposed. 

The current geopolitical situation could serve as a catalyst to trigger mean reversion, in which case J.P. Morgan Research would expect the USD, the Swiss franc and the yen to outperform vs. high beta currencies. The Russia-Ukraine conflict could likely see the Euro weaken vs. other reserve FX given the eurozone’s reliance on Russia for energy. The Swiss franc would also outperform, though Swiss National Bank intervention may eventually limit gains.

Emerging Markets

The main emerging market (EM) disruptions resulting from the Russia-Ukraine crisis are tied to commodity prices, monetary policy and the de-leveraging of crowded positions. However, geopolitical risks are unlikely to derail the prevailing macro trading narratives in EM.

Russia’s credit rating was cut to "junk" status across the three major rating agencies starting with S&P which downgraded Russia from BBB- to BB+ on February 25 and placed the rating on credit watch with negative implications. This was followed by downgrades to junk by Moody’s and Fitch on March 2. For EM corporates, the main concern for Russian corporates would be a technical default due to potential payment restrictions, while Ukraine issuers could face operational disruptions or broader reserve depletion. Russian corporates currently have $99 billion of external bonds outstanding with another $12 billion from Ukraine issuers. J.P. Morgan fixed income indices are following the standardized index approach in response to market disruptions and subsequent impact on the replicability of the indices. Therefore, Russia will be excluded from all J.P. Morgan fixed income indices starting March 31, 2022.

Commodity producers in Australia, Canada, Latin America and South Africa stand to benefit from higher commodity prices and the loss in Russian supply to global markets. J.P. Morgan Research expects Asia and Middle East to provide better stability while Latin America should benefit from higher commodity prices. Asia should be supported by the higher quality composition and greater proportion of a domestic investor base, which should make Asia less susceptible to a reversal in global EM flows, while Middle East should benefit from stronger oil prices. Commodity-heavy Africa should also fare better. For Latin American corporates, the recent sell-off has created better entry points for certain credits such as those in financials, miners and oil and gas exporters. Issuers from these sectors stand to benefit from either rising rates or higher commodity prices.

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