Week in Review: Russia Invades Ukraine

Capping months of repeated denials, Russia launched a full-scale attack on Ukraine on Thursday, as predicted by U.S. intelligence.  Unsurprisingly, market volatility spiked with Western countries responding with sanctions. The combination of heightened geopolitical risk and ongoing inflation pressures saw European and Asian equity markets push lower this week, whilst commodities and traditional safe- haven assets such as bonds and the U.S. dollar strengthened.

The multi-pronged Russian invasion has been marked by indiscriminate attacks on civilian areas and strikes on protected facilities such as hospitals. Ukrainian authorities said about 140 people have been killed, whilst Russian officials contend, they have only targeted military installations in their bid to bring down the nation’s democratic government. United Nations agencies forecast as many as 4 million refugees will flee Ukraine to neighbouring countries if the Russian invasion continues.

U.S. and other Western countries have imposed sanctions, targeting Russia's major banks and restricting exports of technology. The U.S., along with France, Germany, Italy, the United Kingdom and Canada, announced Saturday evening that they would expel certain Russian banks from SWIFT, the high-security network that connects thousands of financial institutions around the world.

Germany has also placed a freeze on issuing the Nord Stream 2 pipeline with an operating licence. The Nord Stream 2 is a 1,200km pipeline under the Baltic Sea, which will deliver gas from Russia to Germany. Understandably, oil prices momentarily surged above $105 a barrel for the first time since 2014 and natural gas prices in Europe jumped as much as 41%.

The week’s earnings reports and economic data generally seemed to take a back seat to the geopolitical tensions. However, the Fed’s preferred inflation gauge, the core personal consumption expenditures price index, rose 5.2% over the year ended in January, up from the prior month’s pace and in line with estimates.

U.S. Pending home sales tumbled to a nine-month low in January amid historically low inventory and eroding affordability in the housing market as mortgage rates rise. The number of mortgage applications registered a drop of 13.1% in the week ended 18 February 2022. U.S. Purchasing Managers’ Indices (PMIs) for February revealed that the U.S. manufacturing and service sectors were growing at a faster pace following an omicron-related lull in January. The house price purchase index advanced 3.3% in the U.S. on a quarterly basis, in 4Q21. In the previous quarter, the house price purchase index increased by 4.2%.

Eurozone and UK business activity rebounded in February after the previous month’s disruptions caused by the omicron variant. The preliminary services PMI in the eurozone climbed to 55.80, from a level of 51.10 in January, whilst PMI data from the UK showed that output increased to an eight-month high of 60.2, up from 54.2 in January.

Germany’s Bundesbank has however warned that Germany may have fallen into its second recession since the pandemic erupted as the omicron variant brought record infections that dragged down economic activity in the first quarter. Having already declined by 0.7% in the final three months of 2021, a further economic contraction in the first quarter of 2022 will signal that Germany has gone into a technical recession (defined as two consecutive quarters of negative growth).

China’s central bank increased liquidity by the most since 2020 amid the Ukrainian conflict, ramping up its short-term liquidity in the banking system. The People’s Bank of China injected a net $45.8 billion into the financial system via seven-day reverse repurchase agreements. Meanwhile, with support from Chinese officials, Hong Kong will test its entire 7.4 million population three times in March to curb a Covid-19 outbreak.

U.S. equities ended the week in positive territory as economic data and uncertainty due to Russia’s war in Ukraine saw investors tone down expectations that the Fed will aggressively hike interest rates. The S&P 500 (+0.82%) and Nasdaq (+1.08%) ended the week stronger, whilst the Dow Jones (-0.06%) was largely unchanged. European and Asian shares were negatively impacted, with the Euro Stoxx 50 (-2.54%), FTSE 100 (-0.32%), Nikkei 225 (-2.38%) and Shanghai Composite Index (-1.13%) all ending the week down.

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Market Moves of the Week

Locally, Minister of Finance Enoch Godongwana delivered his maiden South African budget. Presented with a range of possible choices for the R180 billion revenue overrun in 2021/22, he applied as much of the windfall as possible to reduce government debt – a positive signal to the market that the SA Government is determined to reinstate fiscal discipline. That said, low potential economic growth and high spending needs constrain the Treasury’s ability to show a decisive path to a lower debt ratio over the medium term.

Some takeaways from the budget include:

  1. The corporate income tax rate reduces to 27% with effect from our next financial year ending 31 March 2023.
  2. Personal income tax rates remain unchanged, but thresholds were increased by 4.5% in line with inflation.
  3. The income tax rate for trusts is unchanged at 45%.
  4. Capital gains tax inclusion rates are unchanged for all taxpayers.
  5. There are no changes to Estate Duty and Donations Tax.
  6. It is proposed that all provisional taxpayers with assets above R50 million be required to declare specified assets and liabilities at market values in their 2023 tax returns. The additional information will help in determining the levels and structure of wealth holdings as recommended by the Davis Tax Committee.
  7. Pension funds will soon be allowed to invest as much as 45% of their assets outside SA. Changes to regulation 28 of the Pension Funds Act, due to be published in March, will allow insurance, retirement, and savings funds to invest 35% of their assets offshore, up from the previous limit of 30%. If one includes the 10% allocation for investment in other African markets outside SA, that takes the total international investment allocation for local investors to 45%.

The JSE All-Share Index ended the week down -2.83%, led lower by industrial (-5.93%) and financial (-1.49%) shares, whilst resource shares (+0.14%) benefitted from higher commodity prices underpinned by Ukraine-Russian tensions. By Friday close, the rand was trading at R15.19 to the U.S. Dollar.

Market moves of the week_27 Feb 2022
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Chart of the Week

The multiple rounds of Western sanctions imposed on Russia in response to its actions aren’t expected to act as a deterrent, especially as Russia’s economy is substantially more insulated from financial sanctions than was the case following the 2014 Crimea annexation. Russia has been preparing for this for some time. FX reserves of $430bn (and a further $200bn gold reserves) are enough to cover imports for around 16 months. That said, the implementation of the most severe sanctions in potential future rounds will be challenging given potential spill-over effects to Western economies. Source: Bloomberg, Goldman Sachs

Chart of the week_27 Feb 2022

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