The Russian invasion of Ukraine on February 24 kicked off historic policy actions and moves across global markets. The Russian ruble continues to reach all-time lows and the Russian equity market has remained closed since February 25, while oil has surged over the $130 per barrel (bbl) mark for the first time since 2008 and gas prices have spiked to all-time highs. The global coordination of sanctions has included the European Union (EU), the U.S., the U.K., Canada, Switzerland, Japan, Australia and Taiwan. On March 8, U.S. President Biden signed an executive order to ban the import of Russian oil, liquefied natural gas (LNG), and coal to the United States and also banned new U.S. investment into Russia’s energy sector. The UK pledged to phase out Russian oil imports by the end of the year while the EU unveiled a new energy security proposal to diversify supply away from Russia, focusing on LNG and pipeline gas supply. The G7 also announced plans to strip Russia of ‘most favored nation’ status, with the U.S. House of Representatives approving this measure on March 17.

Russia’s invasion of Ukraine will slow global growth and raise inflation. J.P. Morgan Research views the macroeconomic impact largely through the commodity markets, while the financial linkages between Russia and the rest of the world are comparatively smaller.

J.P. Morgan Research projects a high risk of large energy supply disruptions, with Brent oil price to remain elevated between $100-185 bbl given the possibility of more severe sanctions.

What sanctions have been imposed on Russia and can they change the course of the conflict?

Sanctions and export controls have been broad-based to date, targeting Russian banks, exports of high tech, assets, and the issuance of Russian sovereign debt and equity. Some banks were removed from the Society for Worldwide Interbank Financial Telecommunication (SWIFT) financial messaging system, a key piece of banking infrastructure that facilitates payments of all kinds in the economy. Sanctions were also applied to Russia’s central bank which impacts the country’s more than $600 billion of foreign currency reserves, as well as Moscow’s ability to stabilize volatility in the ruble and protect the economy from the wider disruptions of conflict. This led the Russian central bank to hike its key interest rate from 9.5% to 20% and to the imposition of capital controls. Russia’s central bank has also temporarily banned sales of local securities by foreigners and banned payments of dividends and interest on bonds to foreigners. Around 15% of Russia’s exports are settled in ruble; around 55% are settled in USD and 30% in other hard currencies. Therefore, restrictions on USD settlement can also seriously disrupt these transactions, even if Russia’s trading partners are willing to import. Sanctions were also applied to business leaders (“oligarchs”) seen as close to Putin.

“The conflict has revealed extreme tension between European energy security and the region’s primary energy supplier, a relationship that goes back more than 60 years,” said Joyce Chang, Chair of Global Research. Germany’s decision to suspend the certification process for Nord Stream 2 signals a rethink of European energy strategy. The U.S. followed suit and issued sanctions targeting the company that built the pipeline. As of March 20, large quantities of Russian oil are still struggling to find buyers even at discounted prices. On March 15, the EU announced a fourth round of sanctions that included a ban on new investments in the Russia energy sector including its power sector and a prohibition on all new transactions with Rosneft, Transneft and Gazpromneft but fell short of a full ban on oil and gasoline imports.

The EU has made a historic shift with the 27 members endorsing the use of the European Peace Facility to deliver €500M, or 10% of the total allocated to the facility, in lethal military weapons and additional aid to Ukraine. It remains to be seen whether Putin’s cost tolerance for sanctions will remain high. While Russia is one of the few countries that is running a current account and budget surplus, with reserves of $643.2 billion as of February 18, applying the sanctions to the Central Bank of Russia and removing the country from SWIFT have posted major challenges to moving capital.

What are the macro and market implications of the Russia-Ukraine crisis?

Macro

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 18, we have revised down our 1H22 global GDP growth forecast by 1.6%-pts at an annual rate, a drag that leaves global growth at 2.3% annualized, dipping below potential. We have raised our forecast for 1H22 global CPI annualized inflation to 7.1%, a multi-decade high, and a 3.2%-pts annualized upward revision to our 1H22 inflation forecast. “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 point that to continued inflationary pressures. Russia accounts for well over 10% of global oil and natural gas production. While risks remain skewed to the upside, our baseline view is that the price of Brent crude will remain close to $110/bbl through midyear and that European natural gas prices will hover at about €120/MHw. Curtailing Russian energy supplies further could produce a sharp contraction in its crude oil exports to Europe and the U.S. of as much as 4.3 million barrels per day (mbd). It is hard to know the true extent of the decline in Russian oil exports with our estimates in a wide range of 1 to 3 mbd. Russia exports 4.3 mbd to the U.S. and Europe.  Under the worst case scenario of a full ban, 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 17%, 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 >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 upward 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-yr real yields now back down below -100bp, gold spiked to above $2,000 per troy ounce, and is currently trading at $2,500/oz—highest level since August 2020. Prices are set to remain volatile. While not the JPM 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.

The commodities strategy team sees the following price ranges for commodities: Brent oil: $100-185/bbl, European gas 80-250+EUR/Mwh, copper $9,800-12,000/mt, aluminum $3,300-4,700/mt, nickel $26,500-80,000+/mt, zinc $3,400-5,000/mt, palladium $2,400-4,000/oz, platinum $1,030-1,350/oz, gold $1,800-2,200/oz, silver $22.5-29.5/oz, wheat 1,200-1,800USc/bu, corn 800-1,300c/bu, soybeans 1,600-2,000USc/bu.

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 warrants increasing short-EUR exposure in measured size, as the euro would likely 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 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[1] starting March 31.

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.