investing

Russia’s War on Ukraine: An Economic Explainer for U.S. Investors

Will sanctions against Russia work? How? Will they drastically impact the stock markets and U.S. investors for a long time? Experts weigh in with answers and some global perspectives.

Russia's invasion of Ukraine has roiled global markets. Inflation and the prospect of higher interest rates were already contributing to market volatility. Now, global sanctions and the day-to-day events in Ukraine have made navigating volatile markets even more difficult.

To understand what the war means globally as well as closer to home, it helps to take a broad perspective. The war in Ukraine is resulting in tragic loss of life and human suffering, as well as causing massive damage to Ukraine’s physical infrastructure. It has sent a wave of more than 1 million refugees to neighboring countries looking for housing, food and safety. Amid these ongoing tragic events unfolding in Ukraine, what is happening, and what are potential scenarios and market implications?

Why Sanctions and Not Miliary Action?

The United States, Europe, Canada, Britain, Japan and other countries have responded to the Ukraine invasion by immediately imposing unprecedented sanctions against Russia. Many countries have publicly stated that they do not want a war with Russia, and President Biden has consistently ruled out the deployment of U.S. troops to Ukraine: “Let me say it again: Our forces are not — and will not — be engaged in the conflict with Russia in Ukraine.”

There is a real concern that sending military forces to the region would risk additional escalation with one of the largest nuclear superpowers in the world. Neither the U.S. nor Russia can hope to “win” a nuclear war.

What Are the Goals of the Sanctions Being Imposed?

Throughout the current crisis, the Biden administration's mantra has been "start high and stay high," meaning that the level and impact of the sanctions should be high right from the start. As a result, these are the strongest sanctions ever levied against Russia. 

The U.S. and European allies realize that they will not immediately stop the war. According to Andrea Kendall-Taylor, former Deputy National Intelligence Officer for Russia and Eurasia at the National Intelligence Council and a former senior analyst at the CIA, "Sanctions won't act as a deterrent when dealing with someone like Putin, who is so intent on pursuing maximalist objectives that the economic costs don't factor into his calculus to any meaningful degree. The goal of sanctions at this point is to raise the costs of the conflict, to signal to the Russian people that Putin is taking their country in the wrong direction, and, critically, to strangle Russia's ability to partake in destabilizing activities internationally." 

There is hope that sanctions will cause enough damage to Russia to destabilize the country, devastate the economy, and reduce the support of a Ukraine invasion among the oligarchs and the ordinary citizens of Russia, ending the war more quickly. 

Financial Sanctions

The U.S. and European allies have limited Russia's ability to transact business in foreign currencies such as dollars and euros. These countries have also frozen the assets of multiple Russian banks and those of Russia's central bank, limiting its ability to access $630 billion of its dollar reserves, crippling the Russian government's ability to fund the war.

Russia's banks are also cut off from the SWIFT messaging system. This system is used to transfer money across the world smoothly. Banks can find other ways to send money across borders than using the SWIFT technology, such as secure emails; however, this will be extremely difficult and inefficient.

Western governments have also targeted some of the wealthiest Russians close to the Kremlin. These individuals, including Putin himself, are sanctioned, and their foreign assets are frozen. As a result, wealthy Russians have a much harder time accessing their assets and have lost billions of dollars of net worth in the last week.

Energy Sanctions

Energy represents roughly two-thirds of Russia's exports and 50% of its budget revenues. So, energy sanctions would be a potent factor in crumpling the Russian economy. To date, sanctions on oil and gas have been ruled out by many because of the effect they would have on Europe. The EU currently imports 25% of its oil and 40% of its gas from Russia. 

However, Germany has put the operating license on hold for Russia's Nord Stream 2 gas pipeline to begin operations. The Nord Stream 2 is a 764-mile pipeline that runs under the Baltic Sea, taking gas from the Russian coast near St. Petersburg to Lubmin in Germany. This move demonstrates that Germany is willing to possibly abandon this project to further punish Russia, even though it will have negative economic implications for Germans.

On March 8 President Biden signed an executive order banning the import of Russian oil, liquefied natural gas and coal to the United States. This move will deal another economic blow to Putin. In addition, U.S. Secretary of State Antony Blinken recently traveled to Europe for talks with Western allies. They explored the possibility of banning Russian oil imports as well.  EU negotiations are continuing, and they are close to an agreement on a plan to phase imports out.

Impact on the Russian Economy

According to Elina Ribakova, deputy chief economist at the Institute of International Finance, "We are looking at a double-digit economic contraction already" in Russia. 

So far, the Western-imposed sanctions have had a crippling effect on the Russian economy, with the ruble free-falling more than 30% in one day and the Russian Central Bank responding by drastically increasing interest rates from the current 9.5% to a sky-high 20%. In addition, to high borrowing costs, inflation will further strain the Russian economy and propel it further into a recession. 

Impact on U.S. Stock and Bond Markets

The sanctions have inflicted much pain on Russian businesses, as is evident from their collapsing stock prices. While our clients have little to no exposure to Russian stocks, all investors may feel a bite out of their portfolios. The list of businesses announcing partial or full halts to operations in Russia is ballooning, causing fears of lower revenues among their investors. McDonald’s shuttered all 850 locations in Russia and their actions were shortly followed by Starbucks, Coca-Cola and PepsiCo. Apple has halted exports as well. The list of companies boycotting Russia is growing every day, further putting downward pressure of stock market prices.

In addition, there is significant uncertainty in the future, and the stock market hates uncertainty. The increased tension and anxiety caused by the COVID-19 pandemic makes the invasion even more troubling for U.S. stocks. The flight from stocks to safer bonds will continue as investors become more risk-averse and adopt a wait-and-see approach to the market.

We expect increased market volatility over the coming months as the war continues. The choppy markets will continue until investors understand the sanctions' impact on their pocketbooks. 

Impact on U.S. GDP and Growth

That being said, market analysts still expect strong GPD growth for the U.S. The CNBC Rapid Update, the average of 14 forecasts for the U.S. economy, sees GDP rising by 3.2% this year, which is a very modest 0.3% drop from last month’s forecast in February. The CNBC Rapid Update chart below shows U.S. growth accelerating to 3.5% in the second quarter from 1.9% in the first.

Bar chart shows U.S. 2022 GDP growth forecast peaking in Q2 at 4.3% and then declining to 2.6% in Q4.

CNBC Rapid Update

Impact on U.S. Inflation

We believe spillover from the Russia/Ukraine crisis is likely to have the most material impact on energy prices, causing inflation to creep up even higher. Gas prices have already shot up in anticipation of future disruptions. According to new data from GasBuddy, the national average cost just reached over $4.30 a gallon. Economist Stephen Stanley, with Amherst Pierpont expects that much of the price run-up seen in recent days will recede within a few months, which means the gas price spike should have a short-term impact on growth and inflation. 

Some analysts expect the current inflation surge to peak in Q1 2022 at 6.7% and the core PCE inflation to fall to 3.0% by end-2022 (although Kiplinger’s experts see it ending the year at 6.5%). As inflation normalizes later this year, consumers will get a welcome reprieve. Overall, inflation is expected to become more reasonable, and U.S. economic growth is seen persisting despite the Russia-backed invasion of Ukraine.

Bar chart shows inflation peaking at 6.7% in Q1 and falling to 3.0% in Q4.

CNBC Rapid Update

Investor Outlook

While our clients’ and most investors’ direct exposure to Russia and Ukraine is extremely small, the sanctions imposed on Russia and a renewal of the Cold War conflict are causing fears in the stock market. When emotions run high, looking toward the long-term is more important than ever. A well-diversified portfolio with a wide array of asset classes across different countries, industries and sizes can help reduce investment risks. But, of course, a diversified approach will not protect a portfolio from experiencing short-term losses at a time like this, with massive wartime market volatility. 

About the Author

Stacy Francis, CFP®, CDFA®, CES™

President & CEO, Francis Financial Inc.

Stacy is a nationally recognized financial expert and the President and CEO of Francis Financial Inc., which she founded 15 years ago. She is a Certified Financial Planner® (CFP®) and Certified Divorce Financial Analyst® (CDFA®) who provides advice to women going through transitions, such as divorce, widowhood and sudden wealth. She is also the founder of Savvy Ladies™, a nonprofit that has provided free personal finance education and resources to over 15,000 women.

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