Russia invades Ukraine, causing significant volatility across markets. US equity markets initially plummet, but recover significantly overnight. Brent crude oil breaks $100 on supply disruption fears; aluminum, nickel, corn, wheat also higher

Markets have been exceptionally volatile over the past 24 hours after Russia finally invaded Ukraine.  Global equity markets initially plummeted, although the NASDAQ is now close to flat on the day and S&P500 is well off its lows.  A broad range of commodity prices, from oil and gas to wheat and corn, have risen sharply on the prospect of supply disruptions.  Government bond yields are also well off their intraday lows, with higher commodity prices having the potential to fan already elevated inflationary pressures.  The USD has surged more than 1% on the back of safe haven demand while the euro hit its lowest level since mid-2020.  The NZD has given up all its post-MPS rally (and some) and is back down to around 0.6660.  RBNZ Governor Orr speaks this morning.  

Late afternoon yesterday, Putin ordered a “special military operation” in the disputed Donbas region in Easter Ukraine, effectively ordering an invasion of the country.  Overnight, Russia has invaded Ukraine on multiple fronts with reports of missiles hitting infrastructure around several cities in the country, including the capital Kyiv, and tanks and armoured vehicles entering the country.  Russian forces are reportedly attempting to gain control of an airport on the outskirts of Kyiv, to give it a launching pad to take control of the capital.  Rather than a localised invasion into Eastern Ukraine, Putin appears to have decided on a full-scale invasion targeting regime change.  

Biden has tweeted that the G7 has agreed to move forward with a “devastating package of sanctions”.  He will announce details in a speech expected at about 7:30am.  The UK has announced it will freeze the assets of major Russian banks.   

Predictably, the news in Ukraine was initially met with a broad risk-off move across asset classes, although there has been a sizeable recovery in equity markets over the past few hours.  The S&P500 was down as much as 2.6% on the open but has clawed its way back to be down 1.3% as we write this, while the NASDAQ is almost back to flat on the day having been as much as 3.4% lower at one point (briefly falling into ‘bear market’ territory, defined as a 20% fall from its previous high).  European benchmarks are 3-4% lower while Russia’s main exchange has fallen around 35%, one of the biggest one-day sell-offs in history.  The Ukrainian situation is fluid however and the market is likely to remain extremely volatile in the interim.  

Equity markets are under pressure on multiple fronts, amidst rising risk aversion and the prospect that higher oil prices might keep central banks on track for monetary policy tightening, even with a potentially weaker growth backdrop.

Commodity markets have seen big moves.  Oil and gas prices have rocketed higher with spot Brent crude oil hitting $105 for the first time since 2014, currently trading at around $103 (+5%)  The upward pressure on oil prices stems from market concerns that sanctions on Russia have the potential to disrupt supply in an already tight market, even if those sanctions don’t directly target Russian energy exports.  Meanwhile, European natural gas futures have exploded 36% higher (having been as much as 65% higher at one point), with Germany cancelling the Nord Stream 2 gas pipeline and European leaders pledging to reduce their reliance on Russian gas.  Other commodities have also been affected.   Aluminium and nickel prices are by 2-3%, with Russia being a major producer of both metals, while wheat and corn futures are both up sharply (+6% and 3% respectively) on the back of potential disruption to both Russian and Ukrainian supply.

The USD has surged higher amidst a broad-based flight to quality, with the BBDDXY index rising 1.1% to near an 18-month high.  This would be the biggest one-day move in the BBDXY since June 2020.   The euro is down 1.4% to around 1.1160, hitting its lowest level since June 2020, with the European economy likely to be most impacted from the economic repercussions of Russian sanctions.  Commodity currencies have fallen heavily on the back of rising risk aversion, despite oil and several other commodity markets performing well overnight.  The CAD is off 1% over the past 24 hours while the AUD, NOK and NZD are lower by 1.5% - 1.8%.  The NZD has fully erased its post-MPS rally, again highlighting that global forces, rather than domestic factors, remain in the driving seat for the currency.   The NZD trades this morning around 0.6660.

Market-based inflation expectations have moved higher, reflecting the spike higher in oil prices.  The US 5-year breakeven inflation rate is currently 5bps higher on the day, at 3.20%, having been almost 25bps higher at one stage.  Longer-term inflation expectations, such as the 5-year/5-year forward breakeven inflation rate, are little changed though.

Bond yield plummeted late afternoon yesterday on the initial reports of Russia’s invasion, but they have recovered strongly overnight, no doubt helped by the increase in oil and other commodity prices.  The US 10-year rate fell from around 1.96% yesterday to as low as 1.85% overnight but has recovered to 1.92%.

There has been a flurry of Fed speakers overnight, with the broader message that the Russia-Ukraine conflict was unlikely to get in the way of a March start to the tightening cycle.  With the Fed clearly behind the curve on inflation and the cash rate at emergency levels, the hurdle to not raise rates next month is clearly very high.  Despite this, the market has pared back its Fed rate hike expectations, with six rate hikes now expected by the end of the year and just a 10% chance of a 50bps move priced in.  The US yield curve has bull steepened overnight, with the 2-year rate down 11bps.

In contrast, ECB official Holzmann, seen as one of the more hawkish Governing Council members, said the situation in Ukraine could mean the ECB’s plans for normalising monetary policy “may now be somewhat delayed.”  All eyes are on ECB President Lagarde who speaks after a meeting with G7 central bank heads and finance ministers.  The market has also pared back ECB rate hike expectations for this year, with now just one 25bp hike priced in.

Turning to local developments, NZ rates pushed higher again yesterday morning, with the market continuing to digest the hawkish RBNZ MPS.   The 2-year swap rate was as much as 8bps higher at one point before pulling back late in the day after news of Russia’s invasion to end only 3bps higher, at 2.73%.  The yield curve remained under flattening pressure, with the RBNZ’s hawkish message keeping upward pressure on shorter-term rates while global forces dragged longer-term rates lower.   The 10-year government bond yield was 3bps lower, at 2.76%.

In its MPS earlier in the week, the RBNZ noted that NZ’s direct economic linkages to Ukraine and Russia were small.  The key transmission from the conflict to NZ would be through any tightening in global financial conditions (such as falls in equity markets) and greater inflationary pressure via higher oil prices.  The RBNZ is particularly worried about the latter because of the risk that medium-term inflation expectations could settle above the 2% target midpoint.  In addition, the increase in international grain prices will be a constraint on global milk supply and has the potential to add further upward pressure to dairy prices, all else equal.

On that note, Fonterra lifted its forecast payout for dairy farmers for the 2021/22 season, with the midpoint moving up from $9.20 from $9.60.  The increase to the milk price reflects stronger international prices, on both supply and demand factors, and the weaker NZD.   This would represent a record milk price (the previous record was $8.40).

Russia-Ukraine developments are likely to dominate market proceedings for the next 24 hours.  RBNZ Governor Adrian Orr speaks today on “Tackling Inflation during a pandemic”.   The speech will provide the context for the RBNZ’s 25bps hike this week and outline the challenges ahead.