MARKET WRAPS
Stocks:
European stock markets regained some poise Friday after sanctions laid out by President Biden stopped short of some of the most severe measures investors had thought might be on the table.
The Stoxx Europe 600 rose 1%, led by shares of resource and travel companies, while there were broad gains for most major benchmarks. Russia's Moex stock-market gauge, which endured a historic blow Thursday, rose 12.9%.
Russian forces renewed bombing Ukraine early Friday, with central Kyiv rocked by explosions. Investors are pondering how the fighting, its effect on commodity markets and retaliatory Western sanctions will ripple through a world economy already grappling with elevated inflation and coming interest-rate rises by major central banks.
The U.S. and its allies have laid out stiff restrictions on Russian companies and their ability to interact with the international financial system. The European Union will formally sign off on sanctions Friday that will cut 70% of Russia's banking system off from international financial markets. Officials in Ukraine, the Baltics and the U.K. are calling for the sanctions to go further, cutting Russia off completely from infrastructure that ties together banks around the world.
"I do not think that this highly volatile period is already coming to an end," said Daniel Egger, chief investment officer at St. Gotthard Fund Management. "Right now we have to focus now on what's happening in Kyiv, how bloody the coming days will be, and I would say definitely the Russian sanctions still can be stepped up."
Economic News:
The German economy grew more strongly in the fourth quarter than initially reported by the Federal Statistical Office but the economy may be hit hard now with the escalation of the conflict in Ukraine, said Martin Moryson, chief economist for Europe at DWS.
Drastically rising energy prices can put pressure on the mood and purchasing power of consumers, and crumbling demand and rising import prices could weigh on business sentiment, he said. A recession isn't DWS's base scenario, but Moryson said it can't be ruled out.
"The European Central Bank can do little to counter rising energy prices, but it can do more to counter weakening demand," Moryson said.
Market Insight:
Given the strong bearish sentiment, the market seems to interpret the Ukraine crisis as a systemic risk , Florian Ielpo, head of macro at Lombard Odier Investment Managers. "What used to look like an idiosyncratic risk event, now looks a lot like proper risk aversion episodes."
However, it is important to remember that geopolitical systemic risk events such as Brexit, the North Korea crisis, and the Trump election in the U.S. were all short-lived, Ielpo said. A long-term bear market isn't usually triggered by geopolitical turmoil , therefore, Lombard Odier IM expects the correction to be temporary.
Economic Insight:
As the Ukrainian-Russian crisis could affect U.S. and in particular European growth, major central banks could turn away from fighting inflation to restoring growth and the smooth functioning of capital markets, said Michel Salden, head of commodities at Vontobel.
This, however, depends on how long the crisis lasts, he added. In fact, markets are already revising the likelihood of the Federal Reserve's envisaged interest rate rising path, Salden said. Accordingly, Vontobel expects central banks to shift toward maintaining growth.
Similarly, Pantheon Macroeconomics said European Central Bank officials will react to the uncertainty from the conflict in Ukraine by concluding that all plans to withdraw stimulus must be temporarily shelved.
The key risk for growth in the eurozone is that a further rise in energy prices depresses household spending, Pantheon said. However, the inflation challenge for the ECB isn't going away and the conflict risks another rise in oil-and-gas prices.
"Unless the war in Ukraine pushes the eurozone economy into recession--via tightening financial conditions, a squeeze on real income spending and falling sentiment--the ECB has little choice but to continue withdrawing stimulus."
Separately, Pantheon said the rise in energy prices has darkened the outlook for the U.K. economy.
The surge in prices, if sustained, is set to boost inflation by an additional 1.5 percentage points this year, while consumption could be hit as households' net disposable incomes are expected to fall by about 2.2%. Even if households' real expenditure drops, the economy still might avoid a recession because businesses plan to invest more and stock up on finished goods, Pantheon said.
"But with households' spending equal to 60% of GDP, a period of below trend growth, which will obviate the need for much higher interest rates, surely lies in store."
U.S. Markets:
Major stock index futures were lower and poised for further volatility, as investors sought to make sense of the potentially far-reaching implications of war in Ukraine for individual companies and the wider economy.
"It looks like the military action in Ukraine could be protracted," said Yung-Yu Ma, chief investment strategist for BMO Wealth Management in the U.S. In this case, short-term market movement is difficult to predict, he said.
Rapid inflation and the prospect of tighter monetary policy were complicating the outlook for some traditional safe-haven assets such as Treasury bonds, the dollar and gold, Ma added.
Forex:
The dollar edged lower as global stocks rebounded, although analysts said sentiment is likely to be very volatile.
In times of war, the dollar is "the ultimate safe haven," said Commerzbank currency analyst Ulrich Leuchtmann in a research note. After news of Russian military attacks on Ukraine, the safe-haven yen initially rose against the dollar but soon eased back, he said.
"In times like these it is likely to be the very uneconomic reason that dominates and that is: the currency of the one nation with the military might to defend the free world is the most attractive one."
UOB said based on the daily technical chart, EUR/USD still faces a downside risk for one to two months.
However, the pair has to clearly break below major support at 1.1085 before a fall below support at 1.1000 can be expected, UOB said. The prospects for EUR/USD to drop clearly below 1.1085 appears to be relatively high as long as it doesn't rise above 1.1310, UOB added.
Bonds:
10-year eurozone government bond yields were higher across the board, with Commerzbank saying: "Markets are back in crisis mode but flight-to-safety is unfolding in remarkably calm fashion."
Friday's potential market movers include Italy's end-of-month government auction as well as France's and Spain's announcements of the details of their respective auctions next week.
Societe Generale's rates strategists said the 10-year German Bund yield is expected to remain in the 0%-0.15% range in the short term as investors remain cautious amid the Russia-Ukraine conflict.
"We see more downside risks from a continued flight-to-quality rather than a swift return to higher yields and a normalisation of monetary policy."
As the crisis is only starting to unfold, Societe Generale expects elevated rates volatility in the near term.
Other News:
The baseline outlook for sovereign credit ratings is relatively stable but the latest developments in Ukraine suggest that additional shocks are likely, said DBRS Morningstar.
"As Omicron health fears ease, the effects of Russia's military operations in Ukraine are the key sovereign ratings concern," said Nichola James, co-head of sovereign ratings.
In addition to a refugee crisis in Europe, many countries including Hungary, Latvia, Slovakia and Lithuania, as well as larger economies such as Germany and Italy, as well as Austria, are highly dependent on Russian natural gas.
"The current situation does not have immediate implications for DBRS Morningstar's sovereign ratings, but will have consequences for economies, and could ultimately contribute to downward rating pressure."
Commodities:
Oil held solid gains of around 2% as supply concerns lingered and despite U.S. sanctions on Russia being less severe than feared.
"While sanctions have been levied, energy has been carved out as ultimately, Europe needs Russian gas more than Russia needs to sell gas to Europe," said Stephen Innes, managing partner SPI Asset Management.
Still, "it seems clear that this latest escalation sets the stage for...an extended period of oil and natural gas reflecting a much higher geopolitical risk," he said.
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Aluminum prices fell more than 1% from a decade high after reports that the U.S. isn't planning to make the Russian mining of the metal a target of its sanctions.
DOW JONES NEWSPLUS
EMEA HEADLINES
Russian Forces Push Toward Ukraine's Capital, Bombing Intensifies
Russian forces closed in on the Ukrainian capital of Kyiv and the city came under renewed bombing in the early hours of Friday, as President Volodymyr Zelensky vowed not to surrender and the capital's defenders geared up for urban combat.
Russian forces that had seized the Hostomel airfield northwest of Kyiv in an airborne assault on Thursday joined Russian armored troops that poured in from Belarus, and after heavy battles were on the forested edge of the capital by Friday morning, Ukrainian soldiers on the front line said.
EU to Cut 70% of Russia's Banking System Off From Global Markets
The European Union will formally sign off on sanctions Friday that will cut 70% of Russia's banking system off from international financial markets and place limits on the amount of money Russian elites can hold in the EU, European Commission President Ursula von der Leyen said.
EU leaders gave their backing to the package of sanctions at a meeting in Brussels on Thursday evening. Mrs. von der Leyen said the measures, which were developed in close coordination with the U.K. and U.S., would increase Russia's borrowing costs, lift inflation there and gradually erode the country's industrial base.
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02-25-22 0528ET
