How have markets reacted to the conflict?

Andy McCormick, Head of Fixed Income and CIO

As we sit here today, other than securities either directly impacted by sanctions or at risk of being impacted by further sanctions, the markets have behaved in a very logical way.

Over the longer term, the scenario where we were hoping this would be a brief incursion is now a much lower-probability outcome. That means supply chain issues and inflationary pressure for a longer period of time. We already see this reflected in oil markets but would expect these impacts to spread to other markets, like grain and other things that are produced in Ukraine or Russia.

The response from T. Rowe [Price] to this crisis has been that we have been in a fairly low-risk position heading into this, which positions us really well to take advantage of dislocations, which we believe will occur over the next few months. Markets were already growing more volatile before this event unfolded, and we expect this to exacerbate the situation. As dislocations take place and as our clients become more interested in investing, we are prepared to go out and play offense in the markets and believe that there will be great opportunities to do so.

What are the broad economic impacts?

Among the broader impacts of this conflict, the supply chain issues and inflationary pressures will be top of mind for many investors globally. These things will almost certainly complicate the already difficult task that central banks were facing trying to battle inflation.

The playbook heading into this conflict was for most developed market central banks to begin raising rates in the near term–March in the U.S., for example. In the background, the existing supply chain issues triggered by COVID-19 were expected to dissipate as central banks executed on this policy.

The events in the last few days almost certainly muddy the waters for central bankers, making it all the more difficult to engineer a soft landing, which is a difficult thing to do in almost any market environment.

At this point, we believe that central banks will proceed as planned and rates will begin to increase in March. The picture will be a little more difficult to ascertain as the year rolls on and will really depend on how negotiations and the conflict plays out.

What are we watching next?

As it pertains directly to the Ukraine-Russia crisis, the things that we're watching for that would trigger concerns of an escalation would be the bright lines that exist right now in, for example, one: the flow of gas and oil out of Russia, which appears to be in the interests of most parties.

Two: Russia has signaled respect for NATO treaties, so any inclination that there is a conflict with, say Poland, would be a tremendous escalation and trigger a rethink in terms of the global environment. 

What is our longer-term fixed income outlook?  

In order to look past this, let's go back to the trends that were in place before the conflict broke out a few days ago. Interest rates were moving higher. Credit spreads were moving slightly wider. And that was a logical move based on the fact that central banks are removing the ultra-easy monetary policy that's been in place for the entire COVID-19 pandemic.

Growth and inflation data have been extremely strong, making this pivot in central bank policy extremely logical. One of the results of such a change in policy has been an increase in volatility, which we, as active managers, ultimately welcome with open arms.

In recent history, Treasury yields in the 2% to 2.5% range and high yield bond spreads of about 500 basis points have been extremely attractive to our clients. We expect that over the course of the year that those levels will be reached and that clients will become extremely interested. So our outlook over the full course of 2022 is that there will be growing interest in bonds as the year rolls on.