MANHATTAN (CN) — All it took was for Russia to invade Ukraine for Wall Street to notch one of its best days in more than a year, with markets nearly clawing all their back losses from early in the week.
On Friday, the Dow Jones Industrial Average gained 834 points, losing only 20 points for the week despite sizable losses on Monday and Tuesday. The S&P 500 and Nasdaq gained 95 points and 221 points on Friday, respectively, with each index slightly gaining for the week.
So far, Russia has been one of the biggest losers, economically, from the invasion. Its currency, the ruble, has fallen about 7% against the dollar, while the Moscow stock exchange fell almost 50% at one point on Thursday following the invasion.
Meanwhile, U.S. equities have flourished, despite an early rout on Thursday that quickly corrected itself, with most experts thinking the invasion will pose medium-term problems. “The Russian invasion of Ukraine is likely to increase inflation and job losses,” said Richard Curtin, chief economist of the University of Michigan’s consumer survey.
Part of the issue is that Europe is loathe to go too far with sanctions, despite the fact that they so far have avoided touching Russia’s bread and butter: energy.
“Real pain [for Russia] would come via shutting down pipelines, but many countries are still in the grips of winter weather and can ill afford to change infrastructure overnight in order to not depend on Russian gas,” wrote James Vogt of Tower Bridge Advisors, who also noted some suggested booting Russia from a financial banking network. “Too many restrictions hurt European consumers both at home and in the pocketbook.”
William Jackson, chief emerging markets economist at Capital Economics, said the sanctions imposed on Russia will hit the country’s economy hard and potentially knock 1% to 2% off its gross domestic product, but that a “real game-changer” would be if the European Union and United States could cease all energy purchases from Russia.
“Although the latest round of sanctions fell short of targeting Russia’s commodity exports, the risk remains that they will be targeted at a later stage, which we think will mean that prices stay elevated in the near term,” Jackson wrote. Barrels of crude oil on the West Texas Intermediate hovered around $90 on Friday afternoon.
Beyond the Ukraine situation, nearly lost on Thursday was a report by the U.S. Bureau of Economic Analysis that found gross domestic product increased by 7% during the fourth quarter of 2021, far greater than the 2.3% increase seen during the third quarter of last year. The gains were driven primarily by private inventory investments, consumer spending, and nonresidential fixed investments.
For experts, the data confirm the labor market remains strong, the economic comeback from the Covid-19 downturn has not stalled, and that the omicron variant, as a severe as it was, barely made a blip on the economy at the end of the day.
“The economic impact of omicron has proved milder and more short-lived than anticipated,” analyst Lydia Boussour at Oxford Economics wrote in an investor’s note. “The steep decline in new Covid cases since mid-January is spurring renewed mobility and should support stronger production, demand, and employment and services spending accelerates.”
She noted, however, that weak momentum means GDP growth will hit only 1.5% this quarter. “The U.S. economy is still displaying solid fundamentals, but it is facing rising headwinds from a negative fiscal impulse and significant policy tightening by the Federal Reserve to combat high inflation,” Boussour wrote, predicting GDP growth of 3.5% in 2022.
Another bright spot this week was the U.S. Census Bureau’s report on durable goods, which was nearly double what many had forecast. For January, new orders hit $277 billion, or a month-over-month increase of 1.6%, led mostly by a $2.9 billion increase in transportation equipment.
Even with supply-chain issues, manufacturing seems to be in a very good spot and, as bottlenecks gradually ease, should only get better. There is also the possibility, however, that the Russia-Ukraine conflict could complicate those bottlenecks as energy prices increase.
The leading negative indicator for markets — inflation — continues to weigh on investors’ minds. The BEA found that last month personal consumption expenditures — excluding the typically volatile measures of food and energy — increased by 5.2% year over year, the biggest increase since early 2083.
“The market has been incredibly sanguine about the impact of the war in Ukraine, completely missing the reason the Fed is raising rates and why they can’t slow down their pace of tightening even if economic growth is impacted,” said Chris Zaccarelli, chief investment officer at the Independent Advisor Alliance.
The Federal Reserve meets next month, and already two governors — Christopher Waller and James Bullard — have called for a 1% increase to the federal funds interest rate by midyear. Zaccarelli noted that normally the central bank would have less urgency to raise rates as the threat of war lingers but that the Ukraine conflict will only cause inflation to increase.
“The idea that risk assets should rally because the Fed is less likely to raise rates in this situation seems to be a head-fake to us, as we believe the Fed is as likely, if not more likely, to right inflation now as they were two weeks ago, before Russia invaded Ukraine,” Zaccarelli said. Noting the drop in the University of Michigan’s consumer confidence index this month from 67.2 to 62.8, Curtin agreed the Federal Reserve will need to remain stalwart on raising interest rates. “Even more aggressive actions are now needed to avoid the establishment of an inflationary psychology that can act as a self-fulfilling prophecy,” he said in the monthly survey.
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