Why Russia’s invasion of Ukraine increases inflationary pressure and should be “worrying” for the stock market, says this strategist

Russia’s invasion of Ukraine could lead to more sustained pressure on the US stock market than investors can bet, warns Marko Papic, chief strategist at Clocktower Group on Alternative Assets, who sees inflationary parallels with Yom Kippur’s 1973 war.

When US stocks rose late last week despite the war in Ukraine, investors seemed to embrace the saying “buy with the sound of guns”, Papic said in a telephone interview. But he worries that Russia’s invasion of Ukraine risks putting pressure on the S&P 500 for longer than the market can expect, in part because of its location.

Ukraine is a large country on the border with Europe, located close to the members of the North Atlantic Treaty, Papic said. Any complex military operations near NATO member states run the risk of provoking wider conflict, he said.

What will happen if, say, a Russian military plane turns into Polish airspace and is shot down? Papic suggested. “We can have a lot of events that are very, very volatile.”

Look: Russia’s Lavrov reportedly says World War III will be “nuclear and destructive”

In addition, Russia’s attack on Ukraine risks “meaningfully” adding inflation to the jump in the cost of living that the Federal Reserve already intended to tame in the United States by raising interest rates, which is expected to begin later this month, he said. The conflict is similar in some respects to the Yom Kippur War of 1973, an event that stands out with the creation of a “sustainable risk of a decline in American stocks,” according to Papic.

The parallels between the two geopolitical crises include adding inflation to an already inflationary environment, he said. Papic pointed to the Organization of the Petroleum Exporting Countries, which is taking revenge on the United States for its support for Israel after being attacked by Arab states by imposing an oil embargo in 1973-1974. The shock led to rising oil prices.

“This adds to inflation at its worst,” Papic said.

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Oil prices CL.1,
+ 3.27%

+ 3.27%
rose to more than $ 110 a barrel in futures trading on Wednesday amid concerns over potential supply disruptions linked to Russia’s escalating attack on Ukraine.

Look: “Barrels at all costs.” Ruthless rally raises oil prices above $ 110 as Russia-Ukraine war panics

Russia’s invasion of Ukraine could add inflation in some other “rather complex ways,” according to Papic, who said it focused on palladium, potash and wheat, as Russia is a significant producer of all three. Ukraine is also a major producer of wheat, he said.

The price of a bushel of wheat W00,
+ 6.94%
jumped on Wednesday to levels unseen for more than a decade amid shipping disruptions stemming from Russia’s invasion of Ukraine as it continued its seventh day.

Look: Wheat futures rise to 14-year high due to fears of shortage of supplies caused by the war

Papic says he is worried that Russia could limit its exports to potash, which he says is a fertilizer used by farmers to sew fields. Russia produces about 16% of the world’s potash, while its ally Belarus is also a major global supplier of fertilizer, he said. “If they ban potash exports,” Papic said, the costs could go “through the roof” and countries that can’t pay could potentially face a “food crisis”.

As for metals, Russia provides about 43% of the world’s palladium production, which is important for car catalysts, according to Papic. If Russia starts “messing with metals” by restricting palladium exports PAM22,
aluminum or nickel, “it just adds inflation at a time when we all thought it was kind of peak.”

To tackle high inflation in the United States, which rose during the pandemic, Fed Chairman Jerome Powell signaled on Wednesday that the central bank intends to raise its key interest rate by a quarter of a percentage point after its two-day meeting on March 16.

“With inflation well above 2 percent and a strong labor market, we expect it to be appropriate to raise the interest rate target for federal funds at our meeting later this month,” Powell said in prepared notes on his testimony in Wednesday before the Financial Services Committee. US inflation rose to 7.5% in January on a 12-month basis, the highest since February 1982.

Read: Powell signals interest rate hike by 25 basis points coming to policy meeting in two weeks

The stock market was already worried ahead of Russia’s invasion of Ukraine as the Fed strayed from its highly accommodative stance and investors expected the central bank to start raising its base rate from almost zero this year to fight rising spending for life. Some investors are worried about how aggressive the Fed can be, worrying that rising interest rates too quickly could hurt the economic recovery.

“Now the Fed has to deal with a really complicated situation,” Papic said. “This must be a concern for the market.”

S&P 500 SPX,
+ 1.86%
fell 5.3% in January and fell 3.1% in February, according to FactSet. Major US stock indexes, including S&P 500, Dow Jones Industrial Average DJIA,
+ 1.79%
and Nasdaq Composite COMP,
+ 1.62%,
traded up on Wednesday afternoon after closing sharply lower on Tuesday after Russia said it would launch attacks on the Ukrainian capital Kyiv.

“Ultimately, it could be something like buying a dive,” Papic said of geopolitical tensions around Ukraine. “We’re not there yet.”