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Brewin Dolphin Weekly Round-up

Friday 4 March 2022

In his latest weekly round-up, Guy Foster, our Chief Strategist, discusses the evolving conflict in Ukraine and the potential impact of sanctions.

This week seems to be ending with stock markets firmly on the back foot. US shares are little changed over the week at the time of writing, while European shares have really underperformed due to their proximity to Ukraine and reliance on Russian oil and, particularly, gas.  

Writing a weekly summary of our thoughts on fast moving issues can be a blessing and a curse. It gives a record of our expectations that can prove gracious or damning. Last week’s notes were penned on the second day after the invasion began. Back then, we felt that Western governments would try to thread the needle between inflicting pain on Russia with sanctions, whilst allowing energy to keep flowing to avoid negative economic outcomes at home.  

Strictly speaking, that has probably come to pass but in practice the sanctions response has been considerably stronger than we anticipated. Officially, sanctions have excluded energy, but the uncertainty created by the ever-widening net of restrictions has left companies unwilling to trade, supply, transport or store Russian oil, further tightening a market that was already under-supplied. Disappointingly, OPEC+, the cartel that is so instrumental in influencing the 

oil price, chose to avoid ostracising one of its most influential members by sticking with its pre-ordained glide path of an extra 400,000 barrels of oil per month, rather than a bigger increase to try to address the under-supply. 

Sanctions 

Political and economic commentators have been stunned by the shock and awe sanction response. There was a palpable sense of excitement among governments as they scrambled to add to the combined package in a way which will surely have shocked Russian President Vladimir Putin. US President Joe Biden put it thus: “In the battle between democracy and autocracy, democracies are rising to the moment.”

That was perceived to be a barbed remark aimed at Putin but also a veiled threat to China, implying that any action taken against Taiwan would meet a similar response. There are a few reasons why that might not be a credible threat. For one thing, it should have been easy to carve out energy from existing sanctions packages against Russia. But it would be far harder to identify what to carve out of Chinese sanctions, given the breadth of supply chain integration between China and the West. 

Despite the carve outs for energy, self-sanctioning 

has helped the oil price rise around 60% since the beginning of December. That means while there may be enthusiasm for sanctions against Russia now, they are likely to become less popular as the higher commodity prices begin to be felt in consumer prices for all. 

Sanctions are a negative sum game. Whilst they inflict an enormous cost on Russia, they also intensify the existing anxieties over inflation that have been troubling the equity and bond markets. This week’s non-manufacturing index from the Institute for Supply Management (ISM) described a US service sector that has lost some momentum whilst still expanding briskly. However, a near record number 

of respondents are raising prices, backlogs of orders are lengthening, and supplier deliveries are slowing. Sanctions will only intensify these struggles. 

The labour market is growing  

The ISM service employment index dropped into contraction territory, which might seem to indicate 

a softening jobs market. More likely, it reflects the fact that companies are losing staff faster than they can hire them. The anecdotal evidence presented alongside the results repeatedly referenced staff retention and hiring as the biggest problems businesses are facing. US payroll (jobs) numbers for February showed hiring remains strong. These are closely watched numbers despite the fact that they have tended to suffer huge revisions in recent months.

These numbers seem reasonable with 678,000 new jobs created, which is historically very strong and comfortably ahead of expectations, but not unheard of in the post-pandemic era. 

Despite the inflationary backdrop, there were some reassuringly ‘goldilocks’ (not too hot) elements to the report as well. The labour force participation rate increased slightly, meaning that more people are being drawn into the employment market (more supply of labour) and, most importantly, wages didn’t seem to rise on average in February. In the context of other quantitative and qualitative data, unchanged wages seem like an anomaly. 

Policy response 

Strong jobs growth will keep the US economy on 

a strong footing, even if inflationary pressures are going to contain demand. Understandably, Federal Reserve chair Jerome Powell confirmed during testimony to Congress that he will be recommending a 0.25% interest rate increase when the Fed meets on 16 March, and he anticipates a series of rate hikes thereafter. The Fed is also discussing a strategy on reducing the size of its balance sheet.

Containing inflation is critical to both the economic and political agendas. From an economic perspective, higher inflation means lower growth and can become self-feeding. From a political perspective, 2022 is 

a mid-term election year and Biden’s Democrats stand to cede control of Congress come November. Perhaps most importantly from a geopolitical perspective, having been so forceful with sanctions governments now need to keep them in place until they can be traded for concessions from Putin. If, under pressure from disgruntled voters, they start to be eased while Putin continues with aggressive acts, then the autocrats will have their suspicions about the weakness and short-termism of democracies confirmed once more.  

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