On Market Volatility
The Market Implications of the Conflict in Ukraine
Central banks face a more difficult task tackling inflation.
Andy McCormick Head of Fixed Income and CIO
Key Insights
  • Supply chain issues and inflationary pressures are likely to persist for longer, complicating the task of central banks trying to engineer a soft landing.
  • We expect developed market central banks to proceed with hiking interest rates in the near term, but over a longer-term horizon there is greater uncertainty.
  • Volatility is set to continue in financial markets with potential for price dislocations to occur.
Transcript

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.

Q. How have markets reacted to the conflict?

The markets have behaved in a very logical way in the wake of Russia’s invasion of Ukraine, with the main reactions focused on securities directly impacted by sanctions or at risk of being impacted by further sanctions.

That this would be a brief incursion is now a lower-probability outcome than was hoped. That means supply chain issues and inflationary pressures are likely to persist for longer. We already see this reflected in oil markets but expect these impacts to spread to other markets, like grain and other products sourced in Ukraine and Russia.

"In general for fixed income, T. Rowe Price was in a fairly low‑risk position heading into the crisis..."
— Andy McCormick, Head of Fixed Income and CIO

In general for fixed income, T. Rowe Price was in a fairly low‑risk position heading into the crisis, which positions us well to take potential advantage of dislocations that are likely to occur over the next few months. Markets were already growing more volatile before this event unfolded, and we expect the conflict to exacerbate the situation. As dislocations take place, we are prepared to play offense in the markets and believe that there will be opportunities to do so.

Q. What are the broad economic impacts?

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

The expectation heading into this conflict was for most developed markets central banks to begin raising rates in the near term. The U.S. Federal Reserve was expected to start raising interest rates in March, for example.

The events in the last few days almost certainly muddy the waters for central bankers. This will make it difficult to engineer a soft landing—a complex feat in almost any market environment.

"At this point, we believe central banks will proceed as planned and that rates will begin to increase in March."
— Andy McCormick, Head of Fixed Income and CIO

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

Q. What are we watching next?

We’re watching a number of areas that have the potential to trigger an escalation.

1. Developments around the flow of gas and oil out of Russia.

2. Russia has signaled respect for NATO treaties, but any signs this is changing would be a cause for concern.

Q. What is our longer‑term fixed income outlook?

Prior to the conflict, interest rates were moving higher and credit spreads1 were moving slightly wider. These were logical moves based on the fact that central banks were removing their ultra‑easy monetary policies that have been in place for the entire COVID‑19 pandemic.

Growth and inflation data have been extremely strong, making this pivot in central bank policy logical. One of the results of such a change in policy has been an increase in volatility. Such periods have the potential for price dislocations to occur and buying opportunities to emerge.

In recent history, Treasury yields in the 2% to 2.5% range and high yield bond spreads of about 500 basis points2 have been extremely attractive to our clients. We expect that those levels will be reached over the course of this year. Consequently, this can contribute to growing interest in bonds as the year rolls on.

1 Credit spreads measure the additional yield that investors demand for holding a bond with credit risk over a similar‑maturity, high‑quality government security.

2 A basis point is 0.01 percentage point.

Important Information

This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.

The views contained herein are those of the authors as of February 2022 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.

This information is not intended to reflect a current or past recommendation concerning investments, investment strategies, or account types, advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Please consider your own circumstances before making an investment decision.

Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy.

Past performance is not a reliable indicator of future performance. All investments are subject to market risk, including the possible loss of principal. Fixed‑income securities are subject to credit risk, liquidity risk, call risk, and interest‑rate risk. As interest rates rise, bond prices generally fall. Investments in high‑yield bonds involve greater risk of price volatility, illiquidity, and default than higher‑rated debt securities. International investments can be riskier than U.S. investments due to the adverse effects of currency exchange rates, differences in market structure and liquidity, as well as specific country, regional, and economic developments. All charts and tables are shown for illustrative purposes only.

T. Rowe Price Investment Services, Inc.

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