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Stock market continued its winter correction, although, given the military conflict in Ukraine and its economic implications, losses appear to be moderate. The S&P 500 index lost just over 3 percentage points, while the pan-European Europe Stoxx 600 was down by 3.4 percent. The German DAX (-6.5%) and the French CAC 40 (-4.4%) were worse off, while the Russian market “has left the chat” altogether. Oil and gas prices continued their impressive run, while precious metals also performed well in February. Benchmark yields were rising in the beginning of February but gave back a lot of ground late in the month.
The military conflict did not shock the market, with participants hardly showing any anxiety. Most of the instruments reacted adequately, especially those that were supposed to fall. Bottom line, we have a local (at the moment) military conflict, which resulted in sanctions against the Russian financial and corporate sectors. It is already clear that Russia’s main trading partners will take the main blow: the Netherlands, Germany, Turkey, England, Italy, Poland, and France. As for the Russian market, there is perhaps no need for any comments – as of now it is non-existent and can only be revived by lifting of sanctions / change of political power / a sharp change in the vector of relations between Russia and the Western world.
US manufacturing rose in February as the ISM index of national factory activity added one point to its January readings. Business activity also picked up in February, with the IHS flash US Composite PMI Output Index, which tracks the manufacturing and services sectors, rising to 56 points in February from 51.1 a month earlier.
Eurozone inflation climbed to another record high of 5.8% in February. In addition to energy costs, food prices rose sharply (by 6.1%). The recovery of the Eurozone economy gained momentum in February due to the easing of Covid-19 restrictions – IHS Markit Flash Composite PMI increased to a five-month high of 55.8 in February with flash PMI for the service industry showing similar results.
China’s official composite PMI, which combines manufacturing and services, stood at 51.2 in February, compared to 50.1 in January. After the New Year holidays, the number of new orders increased for the first time since August 2020. A Russian invasion of Ukraine is likely to create bottlenecks in the global supply chain, which could put more pressure on Chinese manufacturers.
Raw materials, precious metals and currencies
The market dealt with “victims” rather quickly, though it took more time to understand how to treat safe haven assets – particular currencies and precious metals. Yes, gold and silver added 5.8% and 9% in February respectively, but one needs to understand that the main growth occurred before the military conflict began. The situation is similar with oil prices, which rose by more than 10% in February (although the first days of March point at no immediate end to the rally) and natural gas, which rose by almost 20% in London. The Swiss franc and the Japanese yen, in turn, remained virtually unchanged.
The US dollar, in general, followed our scenario – it tested the levels around EUR/USD 1.1500, and then turned around to attack the 1.1100 point mark. We talked about the support level at EUR/USD 1.1000 and now, given the new reality, the market may try to storm this zone and head to the levels of $1.0600 per euro in the coming weeks. Obviously, the United States is now a safer place than Europe.
We need to understand that other important, though a bit forgotten issues also affect price movements. Russia is a raw material exporter and supply chain disruptions, as we see with Covid-19, ultimately drive up prices. A possible reorientation away from Russian oil, gas, and base metals will not help reduce inflation in both Europe and the US (to a lesser extent). The policy of negative or zero interest rates in such a situation means only one thing – investors, mainly lenders, receive a negative real return on their investments. So far, the Fed and the ECB are sticking to their earlier plan to decrease their balance sheets and money supply, with the Fed’s first rate hike scheduled for mid-March. The ECB is playing a slower game and is not planning to increase rates in 2022. Everything will depend on data on inflation and the labor market. We will not be surprised if the top bankers decide not to rush to tighten monetary policy.
We are of the opinion that the war in Ukraine is unlikely to break the current long-term trend in equities of developed markets. A week ago, we wrote that the (then) conflict prolongs the correction and increases volatility that began at the beginning of the year, and another wave down would look “appropriate” in terms of market context and sentiment. The US stock market dived below its January lows on the last Thursday of February and began a powerful rally on Friday. On Monday, February 28, futures contracts for US stock indices opened in red, but without visible panic, and then went up confidently. This is usually a sign that the market is searching for a bottom if it has not already found one.