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Drums of war brought upheaval to financial markets

Russia's predawn invasion of Ukraine caused equity markets across the globe to plummet early in the day while energy costs shot upward.

MANHATTAN (CN) — Investors reeled but managed to skirt major calamity on the first day of Russia’s invasion of Ukraine, putting a grim cloud on oil prices expected now to skyrocket in the coming weeks.

News of the invasion broke in what was still Wednesday evening in the U.S., sending futures into a tailspin. Markets opened predictably to a severe downturn, but one that proved short-lived: the Dow Jones Industrial Average immediately dropped more than 800 points at the opening bell but managed to right itself, ending the day up 91 points.

The S&P 500 and Nasdaq began on a similar trajectory but had far more dramatic reversals; the former fell a few hundred points but began its slow climb back into positive territory, finishing the day gaining 63 points, while the latter managed to gain 436 points, a 3.3% increase for the day.

Investors abroad found no such turnaround. In Europe, markets in Germany and France both lost nearly 4%, while the pan-European Stoxx600 fell 3.2%. Japan’s Nikkei fell 1.8%, while Hong Kong’s market declined by 3.2%, and Australia’s market dropped nearly 3%.

Despite avoiding disaster on Wall Street on Thursday, analysts are wary. “I think what it suggests is that a 10% or 20% fall in global equities is actually quite plausible,” Jonas Goltermann, senior economist at Capital Economics, said during a Thursday webcast with investors.

Goltermann said the closest analogy to today’s news — though an imperfect one — is probably Iraq’s 1990 invasion of Kuwait, which caused markets to fall by 20% very quickly before the Iraqis were quickly repelled by U.S.-led forces. He added, though, that markets have already baked the conflict into pricing since this has been a headline concern for the past several weeks.

In the short term, experts are most worried about the impact the conflict will have on oil and other energy prices.

“Specifically, while the conflict will weigh on risk sentiment broadly, the bigger risk here is in the energy space,” Tom Essaye of the Sevens Report wrote in a Thursday morning investor’s note. “Oil and other commodity prices are spiking, which will only put additional upward pressure on inflation and, potentially, create a headwind on economic growth.”

Prices of crude oil, already feeling the pinch from inflation as well as tensions in the region the last several weeks, gained tremendously on news of the invasion. Barrels of crude on the West Texas Intermediate topped $100, though it settled at about $93 per barrel by the closing bell on Thursday.

The oil exchange is nearly higher than it was since 2014, the last time Russian forces incurred into separatist-controlled portions of Ukraine’s costal region, and many experts are predicting barrels of crude will soon eclipse those amounts, with may predicting $130-per-barrel prices of crude in the coming weeks.

Energy prices in Europe already are at the highest point since 1997, according to data published by Eurostat. The European Union imports more than one-quarter of its crude oil from Russia, along with 46% of solid fuel and 40% of natural gas, Eurostat claims.  

In addition to energy, U.S. officials have warned that the conflict could further strain the shortage of semiconductor chips, which are made using neon gas and palladium, materials that are supplied by Russia and Ukraine.

The invasion also is likely to ripple through the Federal Reserve, which many believed would raise the federal funds interest rate by 0.5% next month.

Jennifer McKeown, head of global economics service at Capital Economics, said central banks likely will now err on the side of caution when it comes to raising interest rates. “We think there is a tipping point here where this is looking more like a situation that could start to have impacts on confidence,” she said. “It won’t stop the tightening that’s already planned, but it could delay it a bit.”

Other experts agree the Fed now will tighten its leash and not move too quickly to raise interest rates. “The invasion makes a 0.50 percentage point hike at the Fed’s March meeting much less likely,” said Bill Adams, chief economist at Comerica Bank, “but the Fed is still very likely to raise rates by a quarter percentage point with S.S. inflation far above target, job growth momentum strong, and domestic demand buoyant.”

Adams noted the main impact of the conflict, aside from the human cost, is higher energy prices, which will in turn translate to less consumer spending. These predictions are based on the premise, however, that the Russian conflict remains only in the contested border regions in Ukraine’s southeastern area and not a larger European conflict that involves the U.S. military, Adams said.

“The bigger the conflict gets, the larger the impact to global energy supply will be, the larger the drag on the European economy, and the larger the potential drag on U.S. exports and consumption spending will be,” Adams said.

Russian President Vladimir Putin claims the goal of the invasion is to “de-Nazify” areas of the country — a premise that most in the West think is an overture to install a pro-Russia government in Kyiv.

Putin has made no bones about his belief that Ukraine belongs to Russia and has taken issue with NATO troops stationed at his country's borders. Some outlets are reporting, however, that the invasion caught many Russians off-guard, despite Putin’s saber rattling over the past several weeks.

The invasion was met with several rounds of sanctions by the United States and other members of NATO, which some hope may be enough to pressure Putin to back off Ukraine. U.S. President Joe Biden also sent several thousand additional troops to Germany to prepare for the worst.

“What I’ve been surprised by is how quickly bad things got in Russia,” Goltermann said, noting Russian markets are down 30% for the day while bond yields in the country are spiking. “Their markets are basically imploding.”

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