Oil prices could influence how markets react to the Russian invasion of Ukraine

Traders on the NYSE floor, January 26, 2022.

Source: New York SE

The heavy new round of sanctions by the US and its allies against Russia is likely to push oil prices – and inflation – even higher.

This could pose a greater challenge for the Federal Reserve as it considers rate hikes, and contributes to tighter financial conditions across the board. Economists see energy as a big driver of inflation, but if oil prices get high enough, they can also choke the economy.

For now, sanctions imposed on the Russian banking system by the US and others do not appear to result in a general strain on financial markets, although it is unclear how much Russian oil could ultimately be kept out of the market.

Stocks were volatile on Monday. The S&P 500 ended the day at 4,373.94, down just 0.2%, while the Nasdaq Composite was up 0.4% to 13,751.40.

Investors turned to the Treasury market, pushing the 10-year yield down to 1.8%. The dollar was off the highs it made in overnight trading, and gold rose about 1% as investors sought safer assets.

Oil prices soared, with West Texas Intermediate crude futures trading 4.5% higher at $95.72 a barrel, while Brent International was up 2.7% at $100.55.

Russian assets were sold and the ruble lost more than 20%. Though the US hasn’t directly sanctioned Russian energy, strategists believe the measures will reduce the amount of that nation’s oil entering the market. Moscow is one of the largest energy producers in the world, exporting about 5 million barrels a day. It is also a major exporter of natural gas, which accounts for more than a third of Europe’s supply.

“Whatever happens to oil will affect all other markets… although so far the sanctions are not aimed at curbing oil. They limit the activities of oil buyers and financiers,” said Daniel Yergin, vice chairman of IHS Markit. “Russian shipments are disrupted, but whether it’s manageable or larger will really be determined by events and the risks buyers and suppliers are willing to take.”

The US Treasury Department on Monday announced a historic move against Russia’s central bank, sanctioning a G-20 central bank for the first time. The Treasury Department has essentially banned Americans from doing business with the bank and freezing assets located in the United States.

On Saturday, the US, European allies and Canada agreed to remove key Russian banks from the SWIFT interbank messaging system. The exclusion from SWIFT – the Society for Worldwide Interbank Financial Telecommunications – means Russian banks will not be able to communicate securely with banks outside Moscow.

“I think the markets are behaving… The markets are pretty orderly,” said Marc Chandler, chief market strategist at Bannockburn Global Forex. “It seems like the net effect of that is like both blades of the scissors. That means we’re going to get higher inflation…but we’re also going to get slower growth.”

Chandler said the market is also pricing in a less aggressive Federal Reserve. The Fed is widely expected to hike rates by a quarter point in March, but traders had been betting on a 50 basis point hike before the crisis. The odds are down to less than 15%, Chandler said. One basis point equals 0.01%

Chandler said the market is also pricing in just over five hikes for next year, after pricing in closer to seven.

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But Barry Knapp, founder of Ironsides Macroeconomics, said the rise in energy prices could motivate the Fed to become more aggressive.

“It won’t change the response function immediately, but it should,” he said. “I think energy price pass-through will be higher than at any time in the last three decades. This will increase pressure on the Fed over time. Higher energy prices will lead to higher prices.”

Helima Croft, head of global commodities strategy at RBC, noted that the sanctions process is still in its infancy and it is unclear whether Russian energy will eventually be targeted. For now, she said, it’s difficult to determine how much the new sanctions will keep Russian oil out of the market and what exactly that means for prices.

“Is Russian Oil Becoming a Toxic Asset From an Energy Transaction Perspective? I think we should look at the actions of BP and Equinor and some of the banks that have pulled out of trade finance in the last 24 hours,” she said. “We suspect these are not full lockdown sanctions, but the EU and US are holding sanctions in reserve.”

BP announced that it would divest its nearly 20 percent stake in Russia’s state-owned oil company Rosneft. Equinor said it will begin the process of selling its Russian joint ventures.

Analysts said the direction of markets will be determined by the actions of Russian President Vladimir Putin and whether he will continue the attack.

“In that kind of situation, the banks’ credit bureaus shut it down,” said John Kilduff, a partner at Again Capital. “You will not take any chances.”

Kilduff said if there is a significant loss of Russian oil, prices will rise. “We could get over $125 pretty quickly,” he said.

https://www.cnbc.com/2022/02/28/oil-prices-could-determine-how-markets-react-to-russias-ukraine-invasion.html Oil prices could influence how markets react to the Russian invasion of Ukraine

Jane Marczewski

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