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Market Update

Russia invades Ukraine, U.S. levies sanctions

Date:
February 28, 2022
  • william smith headshot

    Authors

    Bill Smith

    Associate Director
    Balance Sheet Risk Management

    Financial Institutions | Kennett Square, PA

Summary

The major U.S. equity indices ended the week mixed, with the Nasdaq Composite Index experiencing its largest intraday swings since March 2020, as Russia’s invasion of Ukraine largely dominated market participants’ attention.

Russia/Ukraine update

  • Despite diplomatic efforts from the West over the last few weeks to address Russian President Vladimir Putin’s security demands, Russia rejected diplomacy and launched an invasion of Ukraine on Thursday, sparking global condemnation and the imposition of severe economic sanctions from many of the world’s largest economies, including the U.S., U.K., and EU.
    • Fighting continued across Ukraine throughout the weekend with early reports suggesting that Russia’s advances have been largely thwarted with Ukraine remaining in control of its largest cities, including the capital Kyiv.
    • In a bright spot, reports emerged on Sunday that Ukrainian and Russian officials have agreed to talks near the Belarus/Ukraine border and a meeting is scheduled for Monday.
  • In response to Russia’s incursions in Ukraine, the U.S., U.K., EU, and others, have levied significant economic sanctions that target not only Russia’s largest financial institutions but also senior Kremlin officials, including Russian President Putin, in an attempt to cripple the Russian economy and bring Putin to the negotiating table.
    • As the fighting continued through the weekend, the major Western powers ramped up their efforts to support Ukraine with the EU, announcing that for the first time the union will fund the delivery of weapons to a country under attack.
    • In a move likely to have a widespread impact across the global financial system, the U.S. and EU announced in a joint statement that they will remove “selected Russian banks” from the SWIFT interbank messaging system after initial pushback from several prominent European countries.
    • Finally, as of Monday morning, President Joe Biden announced that all U.S. transactions with the Russian central bank are now banned, freezing a significant portion of the Russian central bank’s assets.
  • The situation in Ukraine remains very fluid and market participants will keep a very close eye on the latest developments in the coming week.

Economic Data

  • While last week’s economic calendar was packed with high-profile updates, the data largely fell short of impacting investor sentiment as the conflict in Ukraine dominated much of market participants’ attention.
  • Looking at the calendar, updated manufacturing data topped the economic calendar last week with three surveys releasing updates throughout the week, painting a mixed picture of the state of the industry.
    • After reporting slowing activity in December, the Chicago Fed National Activity Index rebounded well in excess of the consensus estimate as 47 of the 85 measured indicators improved month-over-month.
    • The Richmond Fed Manufacturing Index did not report a similar rebound, however, as the Index defied calls for a monthly improvement and instead fell substantially below both the consensus estimate and January’s reading.
  • Consumer confidence appears to be holding up in February as consumers weigh dwindling omicron case counts against decades-high inflation.
    • The Conference Board Consumer Confidence Index and the University of Michigan’s consumer sentiment survey both reported only modest changes from a month prior.
    • Notably, the recent military escalation in Ukraine is absent from these reports, and some analysts have suggested that the geopolitical uncertainty could weigh on sentiment in the coming weeks.
  • According to the Commerce Department, the U.S. economy expanded at a robust 7% pace in the fourth quarter, modestly higher than the 6.9% reported last month amid record-high inventory levels at car retailers.
    • Looking ahead, the Atlanta Fed’s GDPNow tool, which attempts to forecast the current quarter’s GDP in real-time, is forecasting a meek 0.6% expansion for the first quarter of 2022, down from the 1.3% estimate in mid-February.
  • Finally, jobless claims declined more than the consensus estimate to 260,000 claims for the week of February 19, the first decline in a month.

Interest rates

  • In a volatile week for Treasury yields, the front-end of the curve moved higher while the long end of the curve ended roughly unchanged.
    • Although the long end of the curve currently sits near where it began the week, the geopolitical uncertainty in Ukraine created a volatile session for the 10-year Treasury on Thursday which dipped below 1.85% briefly before ending the week at 1.97%.
  • Continuing a weeks-long theme, the 2s/10s basis compressed further last week, falling to approximately 0.39% on Friday, representing a six basis point decline on the week and marking the lowest level since late April 2020.
  • While interest rates have moved notably higher since the turn of the year, it has been largely on the back of expected Fed tightening and not increased inflation expectations as the Fed-watched five-year forward, five-year breakeven inflation rate has fallen roughly 30 basis points since early January and currently sits at 2.16%, modestly above the Fed’s 2% average inflation target.
  • The pickup in short-term yields last week drove trading activity on our desk as we saw clients look to monetize the relative steepness of the front-end of the curve and mitigate asset sensitivity.
    • To that end, a two-year receive-fixed Fed Funds interest rate swap currently offers approximately 145 basis points of initial compensation, up from 137 basis points of initial compensation at the end of the week prior.
  • Finally, market participants priced in a slightly slower start to the Fed’s rate hiking initiative last week with current pricing suggesting just a 6% chance of a 50 basis point hike in March.

                            Community banks see loan growth in Q4

                            • Looking at fourth-quarter earnings releases from financial institutions across the country, it appears loan growth in Q4 was not just experienced by the largest financial institutions but also by community banks.
                              • According to S&P Capital IQ, community banks notched a median 2.4% increase in total loans, excluding PPP, from the third quarter.
                              • Looking at the loan makeup, CRE loans appear to be picking up steam, experiencing a 1.8% increase last quarter, while C&I loans continued to see declines, down 5.4% from the third quarter.
                            • While it remains to be seen how loan growth will continue into 2022, early anecdotes from some of the largest financial institutions have given cause for optimism.

                                          The look forward

                                          Upcoming economic data releases

                                          • Wholesale Inventories – Monday
                                          • Dallas Fed Manufacturing Activity – Monday
                                          • Markit US Manufacturing PMI – Tuesday
                                          • Construction Spending – Tuesday
                                          • ISM Manufacturing Index – Tuesday
                                          • ADP Employment Report – Wednesday
                                          • Beige Book – Wednesday
                                          • Jobless Claims – Thursday
                                          • Factory Orders – Thursday
                                          • Durable Goods Orders – Thursday
                                          • February Non-Farm Payroll Report – Friday

                                                              Upcoming Federal Reserve Speakers

                                                              • Bostic – Monday
                                                              • Bostic, Mester – Tuesday
                                                              • Powell, Evans, Bullard, Logan – Wednesday
                                                              • Powell, Williams – Thursday

                                                                                  Rates snapshot

                                                                                  Market implied policy path (Overnight indexed swap rates)

                                                                                  Source: Chatham Financial

                                                                                  About the author

                                                                                  • Bill Smith

                                                                                    Associate Director
                                                                                    Balance Sheet Risk Management

                                                                                    Financial Institutions | Kennett Square, PA


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