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Commodity-market turmoil unsettles outlook

Last Week in the City provides a round-up of market movements and the global investing outlook. This covers week ending 11 March 2022.

| 13 min read

With no diplomatic means in sight to halt Russia’s war in Ukraine, commodity markets continued to see extreme volatility. The humanitarian tragedy continues to unfold in the region, with Russian forces now appearing to pause before an assault on the capital Kyiv.

Central banks are preparing for a new wave of inflationary forces from higher energy and raw materials prices. The European Central Bank (ECB) became the first central bank to announce the results of a policy meeting since the war in Ukraine started, surprising the market with a hawkish turn despite the unfolding tragedy in Eastern Europe.

The US Federal Reserve now has another reason to move to tighten financial conditions. Inflationary pressures were extensive even before Russia invaded Ukraine. Data showed US consumer prices rose 7.9% year-on-year in February – a new 40-year high. This has increased the chances of action by the Fed, which needs to tackle price rises before they start to embed in the system via rising wages.

The US, EU, UK and other nations continued their effort to cut Russia off from global capital markets and limit Moscow’s access to certain technologies. The sanctions have primarily targeted the financial, defence and intelligence sectors of Russia and Russian-backed regions of Ukraine – but a US ban on Russian oil escalated the Western response.

NATO members remained clear that member states will not engage militarily in the war, a move that would provoke a significant reaction from Moscow and represent a dangerous escalation.

UK shares have been consistently outperforming markets in the US and the rest of Europe this year, as rising oil prices have supported the commodity-heavy index. This week was no exception.

Global stock indices moved sharply lower. The blue-chip FTSE 100 index was up 2.6% over the week by mid-session on Friday, with the more UK-focused FTSE 250 adding 4.4%. Most other major global indices are expected to post a fifth weekly loss.

Energy price inflation

The immediate squeeze on household budgets by the jump in energy prices was clearly visible on petrol-station forecourts all over the world. Acting like a tax on consumers, rising fuel, transport and heating costs may present a significant threat to economic growth.

  • In the UK, the cost of filling an average family car with diesel topped £90 for the first-time ever, the RAC said.
  • Average US retail gasoline prices surged to an all-time high of $4.173 a gallon, according to the American Automobile Association.
  • Motoring organisation ADAC estimated that German diesel prices had spiked 28% in the six days from 1 March.
  • German heating oil prices also jumped, as homeowners stockpiled the fuel on fears of significant winter price hikes.
  • French fuel costs hit a record, with petrol prices up 27% in a year and diesel prices jumping at an annual rate of 23%.

The oil price gains earlier in the week followed the introduction of new measures explicitly targeting the Russian oil industry by the US and Western allies. This escalation was designed to increase the economic pressure on Vladimir Putin’s regime by limiting access to hard currency to fund Moscow’s war machine and prop-up the ailing Russian economy. However, the squeeze on incomes will also hit economic growth elsewhere.

President Joe Biden signed an executive order (EO) imposing an immediate ban on Russian oil and other energy imports into America. A 45-day grace period was included to allow oil buyers to wind down existing market positions. The EO also prohibited new US investment in the Russian energy sector, with Americans also barred from participating in any foreign investments that provide funding to the industry from elsewhere.

In response, Moscow reminded the world about Europe’s utter dependence on Russian natural gas. A senior Kremlin official referenced Moscow’s ability to cut gas supplies to some of Europe’s largest economies, but said it was not yet considering such a move. This would clearly be another escalation point.

We have every right to take a matching decision and impose an embargo on gas pumping through the Nord Stream 1 gas pipeline

Alexander Novak, Russia’s Deputy Prime Minister.

"In connection with unfounded accusations against Russia regarding the energy crisis in Europe and the imposition of a ban on Nord Stream 2, we have every right to take a matching decision and impose an embargo on gas pumping through the Nord Stream 1 gas pipeline,” Russia’s Deputy Prime Minister Alexander Novak said. “But so far we are not taking such a decision.” Nord Stream 1, which transports natural gas from Russia to Germany under the Baltic Sea, is the longest sub-sea pipeline in the world. It is majority owned by Russian state-controlled group Gazprom.

The UK government announced it would phase out imports of Russian oil and related products by the end of 2022. Boris Johnson’s government said it is also considering banning imports of Russian natural gas, which currently accounts for about 4% of UK supplies.

The US and UK, however, are not large markets for Russian oil and gas, so any home impact is marginal.

The European Union (EU), however, is reliant on Russian energy imports to keep its industry operating and the lights on. Nevertheless, Brussels unveiled an ambitious plan to cut EU imports of Russian gas by two-thirds within a year – and be completely independent of Russian fossil-fuel imports by 2030. This includes sourcing more gas from the US and Africa – and a concession that some countries will need to use more coal in the months ahead, setting back emissions-reducing plans under international agreements.

However, oil prices eased mid-week after the United Arab Emirates’ (UAE's) ambassador to Washington, Yousuf Al Otaiba, said the country was supportive of boosting output. After a near-immediate 17% fall in the price of US oil, the UAE appeared to row back on the comments on Thursday, so the price proved volatile. However, overall, prices moved off a high over the week.

Another attempt at dampening energy prices was made by the International Energy Agency (IEA), which said its members may release an additional tranche of oil from their stockpiles. The IEA was established in the framework of the Organisation for Economic Co-operation and Development (OECD) in 1974 in the wake of the 1973 oil crisis. Members of the IEA last week agreed to release 60 million barrels of oil from their reserves to compensate for the supply disruptions. This represented 4% of the total reserves of IEA member nations.

Food-chain impact

The price of basic foodstuff continued to rise amid concerns about future supply should the war continue and prevent the Autumn harvest or damage crops already in the ground. Exports from Black Sea ports have been halted.

  • Together, Russia and Ukraine account for about 29% of global wheat exports and 19% of the world’s supply of corn.
  • Ukraine and neighbour Belarus are large producers of major inputs into fertiliser production raising prices. However, there is a double price-boost to fertilisers, as the manufacturing processes also requires lots of natural gas, the price of which has soared. Norway’s Yara International temporarily cut production at nitrogen plants in Italy and France, blaming elevated gas prices.

Metal-price rises add to car industry woes

Russia contains significant deposits of industrial metals, with the rising cost of raw materials on supply concerns squeezing profit margins in business and industry. The already-troubled car industry faces further headwinds, as rising costs mount.

  • The London Metal Exchange (LME) suspended trading in nickel contracts after prices doubled to a record $100,000 on Tuesday. The market was distorted after Chinese metals tycoon Xiang Guangda took a large position in the futures markets that would benefit from a fall in the metal’s price. But the market moved sharply higher, requiring him to either post more cash to cover his losses or buy back the position as he got caught in a “short squeeze”. Mr Xiang now faces billions of dollars in potential losses. Prices have since pulled back to about $80,000 a tonne. Nickel is used in stainless steel and is a critical component in the batteries essential for the new generation of electric vehicles.
  • The spot palladium price hit an all-time high on mounting concerns that exports from Russia, which accounts for 40% of all mined production, could be disrupted. The precious metal is mostly used in catalytic converters for petrol-powered vehicles.
  • Aluminium futures trading on the LME surpassed $4,000 a tonne for the first time. Russia is responsible for about 6% of global production and, even without specific sanctions on the industry, many former buyers of Russian product have voluntarily stopped. US sanctions against Russian aluminium producer Rusal in 2018, as part of measures targeted at oligarch and majority owner Oleg Deripaska, caused aluminium prices to spike 30%, as buyers competed for supply from elsewhere.
  • Copper futures reached a record level in excess of $5 a pound in New York trading. The export price of Australian metallurgical coal, used in steelmaking, also reached an all-time high – as did the price of thermal coal, which is used in power stations. Iron ore, tin and zinc prices also rose sharply. The LMEX Index, which tracks six futures contracts in major metals, also surged to a new peak.

Other market implications of Russia’s war

Economic nationalism and deglobalisation were trends that were in place before Russia invaded Ukraine. These two trends will accelerate – and there are other market implications too. Including:

  • Lower growth in leading economies.
  • Prolonging and worsening supply-chain interruptions created by the pandemic.
  • Boost defence spending, led by a significant shift in German policy.
  • Accentuate policies to boost national resilience and domestic production.
  • Result in a rethink of net-zero policies, with an acceleration in the plans for more renewables.
  • A greater use of other fossil fuels in the short term, as countries look for substitutes for Russian gas.

Economics

The European Central Bank (ECB) became the first central bank to announce the results of a policy meeting since the war in Ukraine started – and the announcement’s contents came as a surprise to markets. Clearly concerned about rising inflationary pressures, the ECB said it will wind down quantitative easing (QE) at a faster rate, even as it described the Russian invasion of Ukraine as a “watershed” for Europe. Purchases in its Asset Purchase Programme (APP) will now slow from €40bn in April, to €30bn in May and €20bn in June. Third-quarter APP purchases will be "data-dependent" and may be stopped, after a consideration of the medium-term inflation outlook. APP purchases had previously been set to run at a pace of €40bn over the three months to June, at €30bn in the third quarter and at €20bn per quarter "for as long as necessary" thereafter.

When analysing central bank policy, we think commentators need to consider what they would say – and how would they vote – if they were dealing with the problems they face today.

Geopolitics

Chinese President Xi Jinping called for "maximum restraint" in Ukraine and said China is "pained to see the flames of war reignited in Europe," in his strongest statement on the conflict so far. President Xi expressed concern about the impact of sanctions on the stability of the global financial system, energy supplies, transportation and supply chains.

Russia’s actions in Ukraine have put China in a difficult position. Beijing’s support for Moscow’s

action is highly nuanced and the war will weaken Moscow’s influence in the two-country alliance.

Five Chinese companies listed in New York have been named by US regulators as the first that will be delisted if they do not hand over detailed audit documents that back their financial statements. The US Securities and Exchange Commission said that fast-food giant Yum China, biotechnology groups BeiGene, Zai Lab and HutchMed, as well as technology company ACM Research faced delisting. The announcement resulted in a sell-off in Chinese companies with shares trading in US markets.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

Commodity-market turmoil unsettles outlook

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