soared above $100 a barrel driving equities and currencies sharply lower. The and were hit the hardest by risk aversion, with investors flocking into the safety of U.S. dollars. The Eurozone and U.K. economies are the most sensitive to the slowdown in Russian growth and the sanctions wielded on Russia. Nearly 40% of the gas and more than 25% of the oil imported into the European Union is from Russia. The loss of this supply, combined with rising costs, hits Europe particularly hard. The and dollars, in contrast, are seeing limited losses because Australia and New Zealand do not import any oil or oil products from Russia.
Now, ahead of President Joe Biden’s State of the Union address and Federal Reserve Chairman Jerome Powell’s semi-annual testimony on the economy, Russia is preparing to intensify its attack on Ukraine. It warned Kyiv residents to leave, raising concerns that we could see the capital of Ukraine in a very different state come morning. The assault could intensify just as Biden addresses the nation at 9 p.m. Instead of celebrating the easing of COVID-19 restrictions and the nomination of the first Black woman to the Supreme Court, the focus will be on Ukraine, military spending and inflation. We are not looking for any ground-breaking announcements on America’s involvement. Biden has ruled out putting American troops on the ground, and instead focused on providing security assistance, humanitarian aid, sanctions and freezing Russia out of the financial system. However, the president could announce new measures to ease price pressures. While the U.S. and its allies agreed to release 60 billion barrels of oil from strategic stockpiles, there’s been zero impact on oil prices.
The Federal Reserve is confronted with the same challenges. The Russian invasion promises to keep inflation, which is running at its strongest pace in 40 years, from easing any time soon. The cost of oil is not the only thing rising, are at the highest level since 2008. On the basis of prices alone, the Fed should raise interest rates by half a point this month. However, rate hike expectations have plunged, with the market only looking for a quarter-point hike in March followed by 75bp instead of 125bp of additional tightening this year. Historically, the shock of war on the financial market is short lived, but it is hard to say how far Putin will go. Powell will have to reassure investors tomorrow that the central bank is working to combat high inflation, while balancing the risks that Russia’s invasion poses to the financial markets. There’s a lot of uncertainty ahead, and Powell may find it prudent to be more conservative at this time. While this could be a protracted war, rising inflation is a sticky problem that central bankers need to tackle head on. We believe Powell will make a strong commitment to tightening tomorrow that could provide a lift to and the .
The Reserve Bank of Australia left interest rates unchanged last night, which was no surprise. Governor Philip Lowe expressed concerns that the Ukraine war could add to inflationary pressures, but with wage growth failing to keep pace with price rises, he is in no rush to raise interest rates. The Bank of Canada meets tomorrow. The sold off today despite the central bank's plans to raise interest rates for the first time this year by 25bp. Prior to the Russian invasion, it was widely thought that given the strong labor market and high inflation, it would hike by 50bp. However, protests in February and the Ukraine uncertainty makes a quarter-point hike a more sensible move. Investors sold Canadian dollars despite stronger GDP growth in the fourth quarter and a 10% rise in oil prices.