One of the sanctions that were mentioned by USA and EU is that Russian banks will be removed from SWIFT network, which is for them the biggest threat and fear. Some people said that this sanction would be nuclear option. To make things a little better for Russians is the fact, that in 2014 when invading of Crimea happened and Russia was at that time also threatened with this, they established their own payment system called SPFS.
Still, disconnecting Russia from SWIFT makes international transactions almost impossible. As it could be seen, it was an instant shock for the economy – companies and their foreign customers, especially the ones buying commodities that are in American dollar. Cut off caused big volatility in currency, as rouble is now on historical lows. Experts are estimating that this sanction could shrink Russian economy for at least 5%, however all sanctions combined could be as much as 20%.
Now, that Russia was removed from SWIFT, they will not be the only ones that will suffer. It is expected that dollar and euro will also have some consequences, as US and European banks are the most frequent SWIFT users, that are communicating with Russian banks. This means, that there is expected volatility on both currencies, in addition with mentioned earlier, rouble. The European Central Bank is warning businesses cooperating with Russian companies, that they should be prepared for the worst-case scenario. They are also in touch with banks and discussing how they will fight any unwanted volatility in currencies.
What impact will be seen on Russian rouble?
Whenever there is a war, countries involved usually suffer decreased value of currency. This for example happened one time before to Russia, when they decided to invade Crimea in 2014. Currency at that time weekend for more than 100% - from around 30 RUB to 70 RUB for 1 USD. Value of rouble started decreasing already in November last year, as there were tensions on Ukraine-Russian border, but now that war is happening – and add in this also exclusion from SWIFT, rouble is at the time of writing traded at 109 RUB for 1 USD, which is historical low.
Many banks around the world have disabled option to buy rouble or to have any kind of transaction using it. With this, they want to hurt the currency as much as they can. Main objective is of course, to put it to that low point, it will be impossible to finance the war.
People in Russia are desperately trying to withdraw cash in foreign currencies, as rouble is losing value with rapid speed. Russia said, they were prepared for this scenario and already increased interest rates to 20%, which will lower the impact on rouble. Russian central bank also forbids foreigners to sell their assets on Russian stock exchange. Exporters were also told to sell foreign currencies.
Chart 1: Movement of USDRUB in 5-year timeframe. (Source: Trading View)
Effect on indices
It is hard to predict, to which extend indices will react, as it depends on number of sanctions that will be taken against Russia. It also depends on how war will evolve, if. But here are effects that can already be seen or there is a big chance to happen.
US indices already reacted accordingly to situation on the market, as there was big sell-off in stocks and investors moved their money into more safe things – bonds, gold etc. They were under pressure also before war because of growing of inflation and now geopolitical situation is not helping to them at all.
Despite major volatility and big falls, experts are saying, that at least according to history, investors should not sell the assets now. In 9 out of 12 situations that shocked market like this, indices were back up in around 12 months after the fall – at least when we are talking to the biggest one, S&P 500. On the average return, when similar situations happened, was around 9%. So long-term looking it is positive that it will go back to the level it was, however, short-term view is not the brightest. Nasdaq is in the same view as S&P 500 and it now officially in the bear market, as well as ETF QQQ, which follows it.
Index Dow Jones on the other hand, which is industrial, performed very well during war times – during Cold War for example. It is completely normal that war brings imbalance to the markets, but it is not the only reason. To the help of that comes also rising prices of oil and natural gas, as well as commodities, which are necessary for majority of factories to function normally. For example, in USA price for a gallon of gas is expected to reach more than 3,8 dollars per gallon.
Even though Russian companies are not included in European indices, there are a lot of businesses, that are doing deals or are cooperating with Russian companies, or they are somehow present on Russian territory. Financial companies are expected to take the biggest hit. European STOXX 600 index was already at the lowest point since May last year.
Europe is Russia’s biggest trade partner, which add up to around 37% of total trade or around 80 billion euros annually. If this partnership will stop, it could mean a big hit in GDP for both sides. Relatively smart move from EU companies was that in 2014, when Crimea happened, business with Russia already halved, as they started searching for more reliable partners to do business with, so we could say they were at least somehow prepared for something like this to happen.
Moscow index (MOEX)
As it was expected, also Moscow index (MOEX) fell for more than 47% on the day when attack happened, which was the biggest one day drop in history. Because of that big swing, trading was disabled.
Sell off of stocks continued in the country, as well as around the world. If scenario from 2014 will repeat and investors will move away from the Russian market and search for more stable partners, it will bring big pain to Russian economy. NATO and countries are already attending emergency meetings, where they discuss what sanctions to put next and how to hurt Russian economy as much as possible, so it would cause them to not be able to finance this war.
Chart 2: Movement of MOEX in 5-year timeframe. (Source: Trading View)
End of Nord Stream 2 and rising prices of commodities
Whenever there was war, it had rising effect on prices of commodities – oil, gold, natural gas. It has the same effect now, as price of oil hit the point of 107 dollars per barrel, metals and natural gas also in fast uptrend. Majority of the world warned Russia that there will be sanctions if they will decide to invade Ukraine. Despite them, they decided to attack, as Vladimir Putin said that they are well prepared to any scenario and that they have back up plans. Meanwhile, Germany decided to hold the approval of pipeline, Nord Stream 2.
Nord Stream 2, pipeline that is connecting Russia with Germany and is intended for delivery of natural gas, could bring around 110 billion cubic meters of gas to Europe every year, of course with cooperation of already working natural gas pipeline, Nord Stream 1. As Russia exports around 40% of all natural gas to Europe. With stopping it, Europe will face typical supply and demand scenario, as there will be bigger demand than supply and it will cause the prices to go higher as they are already because of inflation. Besides this, Russia is also exporting around 26% of all crude oil imported in Europe.
Europe is now on a mission, how to prevent the prices for 1000 cubic meters – which according to Dimitry Medvedev, will reach 2000 euros. They are in talks with USA and The Gulf countries, if they could help with the import, but it remains unknown if they will be able to export that much, to fill the gap.
How will markets and economy react to high prices of energy?
As mentioned earlier, prices of oil at one point already touched 107 dollars per barrel, which is the first time in 8 years. Analysts from JP Morgan are predicting, that by the end of the year, price of oil will be on 125. However, price estimated was before the actual war, so give the circumstances it could go even higher. Quickly rising prices in energy are bad for economy, as the only ones getting something of it are oil companies. Factories need energy for normal functioning, but as the prices are getting to record highs, a lot of companies could bankrupt. Also, money spent for the bills could be used for better things, such as expansion or investment into employees. Analysts are warning, that if prices will not stop to rise, we could face a bad recession.
The whole world is facing energy crisis, however it seems that Turkey and Egypt took it the hardest, as in Turkey prices for companies went up by 400% over a year. Many are saying that continuation of growing prices could have fatal results. Egypt on the other hand is also a country, which has deficit in the accounts, and they cover it with short term capital inflows. Countries like them are getting big import rates, but constant pressure on the currency has cause currencies to underperform.
All this makes worries regarding inflation even bigger because it is great risk for the economy. Increase in energy prices usually lower expectations for growth of economy in give country and raises inflation expectation in short-term. All of this has a negative effect also on stock market, as companies are usually underperforming.
Chart 3: Movement of WTI Crude Oil in 5-year timeframe. (Source: Trading View)
Nobody sane in this world wants war, but we cannot change the fact that wars can happen anytime. And sadly, we are now witnessing one, that is expected to be the biggest since second world war. Sanctions already taken, markets already in shock, protests around the world and chaos in Ukraine. None of it, short-term wise will have positive effect. However, wars bring us opportunities on the markets in other sectors than stocks – commodities, forex, indices. Do not forget that geopolitical shocks like this are not common, so do not miss on the opportunities that market is offering you!