OVERVIEW

 

Just as COVID-19 seemingly receded to the point that we could emerge in a new normal, on February 24th Russian forces invaded Ukraine. Equities, which were already negative for the year, initially moved even lower while commodities added to their gains, fueled by concerns over supply chain issues and access to critical raw materials.  Fears that inflation, already at uncomfortable levels, could surge even higher kept investors from seeking safety in fixed income securities and drove bond yields up significantly.

 

Following the invasion, equities rallied throughout most of March, which reduced losses for the quarter. The S&P 500 ended the quarter down 4.6% while global stocks dropped by 5.4%. Bonds have typically provided investors with a ballast against equity drawdowns, but not this quarter. The Bloomberg U.S. Aggregate Bond Index dropped 5.9%. For the first time since the first quarter of 2018 and just the second occurrence since the global financial crisis, both the S&P 500 and the Bloomberg U.S. Aggregate index finished the quarter in negative territory. The U.S. 10-year Treasury yield rose 87 basis points over the quarter from 1.51% to 2.38%, its highest level since May 2019.

 

Commodities were the big winners in the quarter, returning 25.5%. Supply chain issues, exacerbated by the strategic role Russia and Ukraine play in global resource markets, drove many individual commodities up substantially: nickel (+55%), natural gas (+51%), WTI crude oil (+33%), wheat (+30%), and corn (+26%). Food and energy commodities, items that significantly affect the lives and pocketbooks of global consumers, are at the heart of this conflict. Russia provides 17% of the world’s natural gas and 12% of its oil,1 and Russia and Ukraine generate roughly 34% of global wheat traded.2 With Russia only committing to export to friendly nations and Ukraine trying to execute planting season amidst a war, the price of wheat jumped by 30%. Input costs, such as fertilizer, have also risen dramatically and now sit at levels not seen since 2008 when oil prices were over $150 per barrel.3 The war has caused other countries to turn inward and limit their exports. In mid-March, for example, Indonesia, the world’s largest producer and exporter of palm oil, more than doubled its maximum levy on palm oil exports so that it could subsidize domestic prices and distribute more than 200 million liters of the commodity across the country each month.4

 

Western countries responded to Russia’s military aggression with economic warfare – several rounds of financial sanctions that were increasingly severe and focused on undercutting Russia’s economy. As a result, Russia’s currency, the ruble, imploded in value. At the time, President Joe Biden correctly cited this as an example of the economic hardship Russia would face as a result of the invasion.5 Russia might have taken comfort in its $600 billion war chest of foreign exchange reserves, but in an unprecedented move, countries around the world confiscated these assets.6 Even Switzerland, traditionally a neutral haven in times of war, froze Russian financial assets, including those of Vladimir Putin, Prime Minister Mikhail Mishustin, and Foreign Minister Sergey Lavrov.6 Notably, Russia had already sold the majority of its U.S. Treasury holdings in 2018 and retained only approximately $5 billion in total exposure.7,8

 

The initial decline in the ruble was severe: -48% from where it started the year. In response, Russia raised domestic interest rates from 9.5% to 20%.9 Russian authorities also capped the amount of dollars that residents could withdraw from foreign-currency bank accounts and barred banks from selling foreign exchange to customers for six months.10 European countries continued to purchase Russian energy but those transactions were carried out in foreign currencies.11 Putin then announced that foreign nations that aligned themselves with Ukraine must buy Russian gas with rubles, gold, or bitcoin rather than dollars and euros, thereby forcing sanctioning nations to support the Russian currency.12 The ruble rallied 71% from its March 7th low, and by the end of the month it had shockingly increased by 3.8% since the February 24th invasion.