Conflict in Ukraine. Commodity markets also suffering the shock.

The Ukraine conflict is also rattling commodity markets

The conflict in Ukraine is shocking people the world over, taking both a social and an economic toll. The economic consequences are occurring mainly in the area of commodities. That is because Russia currently provides 41% of European gas imports and 10% of global oil production. Besides that, the country is also a dominant exporter of copper, palladium, nitrogen fertilizer, potash, nickel, and aluminum.

For now, the prospect of having to do without Russian gas is explosive for western countries, especially those in Europe. Precisely that is appearing more likely, however. In particular, that is because gas and electricity prices have skyrocketed, and gas supplies in Europe are 26% below their five-year average.

How will Europe's gas supply change over the medium term? First, the major natural gas trading companies – probably those in Europe and the US – are most likely to profit from the shortage in the overall economy. Second, the major electricity producers are seeing their revenues soar thanks to rising prices and stronger pricing power. The effects extend further than that, however. The possibility of fundamental changes to the energy market cannot be ruled out.

A variety of scenarios for transforming the energy market:

• In the future, Europe will attempt to replace Russian natural gas with American gas and some Norwegian gas.
• In the next two years, the US could become the world's largest exporter of liquefied natural gas (LNG) – with Europe becoming the largest buyer.
• Europe will speed up its expansion of renewable energies as well as its efforts to conserve energy. By 2025, wind and solar energy are expected to account for one quarter of Europe's energy mix – that is, more than the energy derived from fossil or nuclear sources.
• There will be greater promotion of Minergie Standards, building automation, and mandatory energy management in industry and data centers.

Financial market: How will the Fed respond to the crisis?

The shock to commodity markets is hitting the economy at the worst conceivable time with respect to inflation and monetary policy. Central banks had been wanting to roll back their expansionary monetary policies. Monetary policy makers are now faced with conflicting objectives. On the one hand, the central banks would need to pull the reins of monetary policy even tighter given the rising inflationary prices. On the other, stepping on the monetary policy brakes means the only way to stop inflation is with the tools of fiscal policy.

The escalation in the conflict could force the Federal Reserve (Fed) to take its foot off the gas pedal so it can better judge how the war is affecting bond markets and the economy as a whole. That kind of shift could allow stock markets to rally. However, it appears obvious that conflicts, wars, and sanctions are destructive and, at least partially, deflationary in strictly economic terms.
 

What does the present situation mean for investors?

In the short term, the clouds on the financial market horizon could get darker. Nobody knows what course the crisis in Ukraine is going to take. It would be pure speculation to bet on the timing and extent of an impending correction. For that reason, Credit Suisse is standing by two beliefs in its House View:

• A high level of diversification using those investments that are affected less by the crisis and the return to normal monetary policy (for example, alternative investments, energy, financials, senior loans, selected emerging market bonds, or other bonds with variable interest).
• Equity holdings corresponding to one's strategic asset allocation. We would possibly increase that with additional purchases in case of another market correction.