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February 25, 2022

How the Ukrainian-Russian Conflict Is Impacting Markets

A Russian invasion meant to topple Ukraine's government could lead to severe sanctions by the West, which in turn may prompt Russian President Vladimir Putin to cut off vital commodity exports, dealing a blow to the global economy, a senior RBC Capital Markets strategist warned this week, hours before the Russian military launched widespread attacks against Ukraine.

"We are facing a very high risk that we are looking at a major military confrontation in the heart of Europe," Helima Croft, RBC Capital Markets managing director and head of global commodity strategy, cautioned during a market update Wednesday hosted by City National Rochdale, City National Bank's investment advisory organization.

City National Bank is an affiliate of RBC Capital Markets, LLC.

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How Might the Russian-Ukrainian Conflict Affect the Economy?

Restricting commodity flows may be painful for Russia's president, but “the broader play he's making is for the restoration of the Russian empire and the Russian sphere of influence," said Croft, a former senior economic analyst with the U.S. Central Intelligence Agency.

“He's willing to risk sanctions, he's willing to risk the economic fallout," Croft added.

Russia ranks among the world's largest oil and natural gas producers, is the top palladium exporter, and, with Ukraine, acts as a major crop supplier. The two countries account for about a quarter of the world's global wheat exports, with Ukraine also serving as a significant producer of corn.

Croft referred to Russia as a "commodity superstore" that could significantly drive food and energy inflation. “Russia is uniquely poised to be able to raise the misery index on Western consumers," she said, also noting Europe's dependence on Russian gas and coal.

The Sanctions on Russia

Within hours of Croft's comments, major news outlets carried reports that Russia had launched attacks against several cities in Ukraine, including its capital, Kyiv, and that oil had soared past $100 a barrel for the first time in eight years amid a broader rise in commodity prices.

Ukrainians fleeing the attacks reportedly started arriving in Poland on Thursday, and an official reported that Ukraine had lost control of the damaged Chernobyl nuclear reactor site.

President Biden announced that he and other G7 leaders had "agreed to move forward on devastating packages of sanctions and other economic measures to hold Russia to account," including blocking the country's major banks from the U.S. financial system. Banks blocked by the sanctions include Sberbank, VTB Bank and three other major Russian financial institutions.

Will the Crisis in Ukraine Impact the Economy?

Russia's attack roiled global markets Thursday, with the Dow Jones Industrial Average losing 800 points before regaining some ground.

Before the attack on Wednesday, City National Rochdale Chief Investment Officer Tom Galvin offered assurances that his investment team has developed plans for an extraordinarily wide range of potential outcomes from Russia's aggression against Ukraine.

The team was staying the course with client portfolios at the moment but "we're being ever watchful" to see how events unfold, he said.

"Barring the worst-case outcome, we see limited negative impact on our positive view for a multi -year expansion in the U.S. and our overweight to risk assets. Volatility in the short term, though, will likely rise until the crisis is over and equities could come under varying degrees of pressure," Galvin said.

"History shows the impact on equities from geopolitical tensions tend to be short-lived and modest on average. Should the worst case unfold, we believe the European economy would be impacted much more than the U.S., reinforcing our underweight to European equities," he said.

The worst-case situation, which would include a Russian takeover of all Ukraine and onerous Western sanctions against Russia's financial systems, would increase the risks for a U.S. recession and capital loss, according to Galvin.

U.S. markets could get clobbered, supply chain challenges could intensify and downside risks would rise in a worst-case scenario. In that case, Galvin said, "rest assured we would take steps to help clients preserve their wealth."

Chart - Markets Tend to be Resilient

Fed Likely to Continue Raising Interest

The Federal Reserve's signal that it will raise interest rates this year amid recent high inflation amounts to a vote of confidence in the durability of the U.S. economy, Galvin said, while also calling the fundamental economic backdrop strong at this point.

He expects the Fed to maintain that path unless major exogenous shocks arise from the Ukraine conflict, in which case the central bank may need to pull back and offer more policy support for the economy.

Given the volatile circumstances, City National Rochdale CEO Garrett R. D'Alessandro said, “being nimble and dynamic, we feel, is a good approach."

RBC's Croft said the Biden administration has worked hard to prepare for a Russian Ukraine invasion, with many on the staff having learned from a slow response to Russia's Crimea invasion in 2014. White House officials have been talking to Qatar about getting flexibility on liquefied natural gas supplies and are working with Asian importers on routing supplies to Europe, she said.

Russia's Impact on Oil Prices

U.S. officials also could tap the Strategic Petroleum Reserve to ease rising oil prices, she said.

If the U.S. and other Western nations blacklist Russia's most important financial institutions and expel the country from the SWIFT system, "I think it's very conceivable that Putin will respond with what will cause us pain," notably rising food and gas prices and a shortage of the precious metal palladium, said Croft.

Germany's decision before the invasion to halt the Nord Stream 2 natural gas pipeline from Russia, a key part of that country's transition away from reliance on coal, is a "very significant political blow to Russia," she said.

Even so, Putin, who has organized the largest deployment of Russian troops since World War II, appears to want "something bigger" and may be willing to take on economic risks, according to Croft. She also cautioned that Putin shouldn't be considered a rational actor.

Croft noted that Putin has been rehashing Cold War grievances and has reportedly called the collapse of the former Soviet Union the 20th century's greatest geopolitical catastrophe.

"I don't think we should be sanguine about how this situation is likely to evolve," Croft remarked.

Galvin encouraged City National Rochdale clients to talk to their financial advisors about any questions or concerns.

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