Fidelity's CIO on the impact of Russia sanctions

Fidelity's CIO on the impact of Russia sanctions

As the humanitarian disaster continues to unfold in Ukraine and with the backdrop of more severe sanctions against Russia, Global Chief Investment Officer Andrew McCaffery talks to Carsten Roemheld about the economic consequences, the market implications, and the positioning of Fidelity's core asset allocation.

 

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The crisis in Ukraine and the human tragedy unfolding there has continue to shock the international community as the Russian invasion has intensified, Western nations have now imposed tougher financial sanctions against Russia, including freezing the assets of its central bank and removing a number of Russian banks from the Swift international payment system. If there is no diplomatic solution, which seems unlikely at this point, there's a concern that this war could drag on for a long time. I'm casting room ahead, and I'm joined now by Fidelity's chief investment officer, Andrew McCaffrey. Andrew, thank you for joining me. A pleasure. It's good to be speaking with you again, Kirsten. Thanks, Andrew. As I mentioned, Western countries have this week announced a raft of economic sanctions against Russia. What impact have investors been grappling with and what else should they expect? Well, I think the direct impact is that we found through the actions not just of the West, but through how the Russian authorities responded that several markets, especially those for Russian and Belarus in securities, have basically reached the point where there is no price discovery because the markets are not closed that it's impossible to deal. That's the functioning of those markets has basically stopped and then that's obviously impacted on two related areas. So when you think about the depository receipts markets, whether it be the guys in the UK or the ADL's in the US, those have seen a very significant impact as well. And the flow through into bond markets are local currency again, the same thing that you've not seen the ability to transact. And we have seen in the spot markets that four effects that it's been very volatile, obviously on the initial moves, but obviously forward markets where you've got the impact of these very sharp interest rate terms and again, the ability to think in any time scale at this stage with the events and how they are unfolding, that they're not working very efficiently over in very liquid form. So challenging environment there , there are some ripples. But we've seen very limited contagion to date, and in some ways that we have had is is most probably more as investors have taken stock of what will be the broader impact and how that will influence countries and also markets more broadly over time. What do you see as being the wider impact on central banks right now? Are we likely to see a slowing in expectations of tightening? So I think there's a slightly different profile, depending on which of the countries of origin we look at. I think for Europe there clearly has to be that impact being considered very, very clearly within policy settings. And now we had not that long ago an ECB meeting where expectations jumped significantly around how hawkish they would be and how the unwind of quantitative easing programs of interest rate increases that could follow that. And that will, we really believe, won't be rolled back to. There will be a measured and thoughtful process around what does this mean and take stock and look at the data more closely. The challenge is that, as we've seen only in the last few days is that inflation has hit new nominal highs in Europe. That growth through the energy channel, we think sadly will be a very strong consumption tax in the way that you're seeing gas and overall energy markets performing. And this is also coming on the back of what we'd seen of Europe opening up and a recovery that was building, obviously, you know, hitting that very much sort of head on with events that take place. And then combined with that, you have supply chains, you know, being challenged again for the US, I think it's slightly different in that, you know, we've always thought that they would not be as aggressive as the market was starting to think. You know, only looking back two or three weeks ago, mainly because we felt that there were going to be forces at work given the debt burden, given the risk of slowing of the economy as the year went on, that they would want to talk the market into doing the action for them and then roll back a little bit. And I think that what you've seen only this week with Jerome Powell speaking is that those expectations of greater tightening in March have been taken back, and so it's likely they will increase rates, but more like 25 basis points now. And secondly, though, that I think for the U.S. , the inflationary pressures, you know, stay very real. And so you know, what we may find there is that just as we're fearing, stagflation may give way to more recessionary impulses for Europe. When we look to the U.S. , is that that stagflation, you know, looks to be very much in place where growth isn't going to decline aggressively and immediately, but it is going to start to slow. And so you might find some good data numbers, poor data numbers, but strong inflationary numbers still persist in the. You mentioned the high energy prices that are a huge tax for consumers and companies, we've already seen some curtailments in certain high energy intensive industries. There's also food prices could be another very critical point as Russia and the Ukraine are big global supplies of grain and fertilizers. So what are the macro consequences of these moves? Do you really think now recessionary scenarios are more likely at this point? Well, I think that, you know, the risk of that is growing, and when we look at what we felt were the types of scenario that could play out and clearly events have increased the risk, as we said over the last couple of weeks of stagflation, really, you know, being at the top of that list. But I do think that also the odds of this tipping into a more clearly recessionary environment for some areas, not necessarily for everywhere is going to be a much greater risk now. And I think to your point, there are a number of things that should be taken in consideration that, you know, when we look at Ukraine is been a significant producer of many valuable commodities and including, you know, food as well. That has been important for for Europe, but its impact in that broader sort of ripple across different areas of the world. And that isn't going to go away necessarily very quickly. Obviously, we all hope, given just the humanitarian crisis that's taking place, that this can be resolved and we can find cessation of of what we're seeing today. But the challenges that some of this will roll on, even if that were to occur. And I think that, you know, central banks again sort of build this into our assessment. I think what it does cost them is just mean that they will be, you know, slower taking stock, waiting to see what the real outcomes are from this and certainly not carrying through on very aggressive policy actions just at this stage. We're always looking for historic precedents, does this remind you of the playbook that developed in the 70s when the world faced an oil price shock, which had severe economic consequences? So, you know, it's one where we've grappled with for a while, would that be something that we do see developing? And I think the challenge is that if we look at just the statistics that you know, this week we had, you know, one of the amazing sort of data points is that on the 3rd of March, it actually is the second highest, which is surrounded by individual days that we saw in the seventies of this sort of, you know, impact onto commodity prices and the sort of flow through impact across so markets from that. So, you know, it is something I think we just take seriously. I think the risk as well is that it creates this more volatile economic and then market environment. And markets in reality have been, you know, relatively, you know, well disposed in that we've seen, you know, setbacks but then ability to recover. I think the challenge as we come through the course of this current week is that your markets are starting to get more nervous. We haven't seen full blown contagion. But we have seen signs that, you know, concern about what does this mean playing through Europe? What does it mean to, you know, to companies, to supply chains, to their ability to hit those earnings targets that were getting more favorable as we were looking, you know, through the course of twenty two? It's also going to play back a little bit in some of the nervousness that we saw in bond markets in that you'll see government bond markets clearly as we have seen that yields can stabilize even come off a little bit, but it's going to feed through into more concern again around some of the corporate credit as we see. You know how this plays out at the individual company level. If you're going to keep costs and inputs up potentially hits demand to a degree. And then obviously, as I said, the estimates were fairly optimistic. And so, you know, we started to see a little bit of reprice in the market relative repricing going on as well. This is a very complex picture, so how is this all feeding into your core asset allocation for you at this point? So I think that the fortunate thing and I've touched on this before we came into this period for other reasons, you know, looking at what we thought were the risks around some of the central bank, you know, discussion and what they were looking to achieve in terms of financial conditions, but also that the way that the markets still felt slightly ahead of themselves in where they were price, especially in risk assets. So we came in with a neutral to risk a lower risk profile than we'd had on our asset allocation, tactical asset allocation profile. And some of the risks embedded within that that we were trying to also reflect is that, you know, within the equity market is not have such a positive stance that it lowered us in favor of the U.K. , but also Japan and looking to Asia and China. We still believe that that's correct. Obviously, in the volatility we're seeing, that may well presents an opportunity for us to, especially when we look to Asia and China to increase weightings relative to the developed world in credit. Again, this is really, you know, impacted on two thoughts around, you know, how we were seeing high yield was already we felt a little tight in pricing, so taken down risk or underweight there as we see how markets play out here again, when we look across the range, we feel that value is being created, that some of the pricing impact is actually misplaced because of the sustainable impacts into some of these countries, and especially when you've got something I haven't discussed further today. But is that China stimulus starting to pick up and the credit impulse that's providing both for China but will ripple out some for Asia, we think. So that slightly impact in that it's where you take your risk across markets. And again, from a government bond perspective, we're not convinced that yield to declined too much further in the US. But in reality, when you look to Europe, you're likely to find that markets will be very cautious and take, you know, yields down again, and they don't see policy change in as much as they were thinking in the, you know, a few weeks ago. And then lastly, I think that one of the challenges here is looking across to how you navigate the foreign exchange markets because clearly we're in a, you know, degree of very cautious some, you know, heightened concern. And so how that ripples through markets in a bid to the dollar. Again, a lot of people haven't built up dollar deposits around the world and how the Fed responds and what their words are around any rate move this month will be a very important one for that. But at the moment, that knee jerk need for a safe haven is very much favoring the dollar. We had better wrap up here, thank you very much for taking the time to talk to me, Andrew, today, and thank you for listening. You can read more from Andrew and our investment teams on the crisis in Ukraine, on your local Fidelity website or at Fidelity International dot com. The producer today was Holly Eastman with technical support from Connor Bailey from all of us at Fidelity. Goodbye.

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