The markets reacted strongly to the Russian invasion of the Ukraine on Thursday, with the S&P 500 dropping 94pts at its low. After President Biden assured action would be taken to mitigate the negative impact on the economy (SPR release), the S&P 500 rallied strongly and finished the day up 63 points. The NASDAQ finished up 3.34%. The price volatility was extreme in a wide range of commodities from oil to natural gas to corn and palladium as the markets attempted to sort out the impact of the invasion.

With this in mind, let’s review 10 possible outcomes from the invasion.

3 Negatives

1. Obviously, the energy and commodity markets are reacting strongly to the potential of the EU and the rest of the world losing a portion of Russian energy output. At one point, WTI was above $100 a barrel, but reversed to finish the day up only $1.00. US natural gas had a similar move and ended the day down 1.20% to $4.57. While these extreme price moves are challenging in the US, they mask the problems facing the EU who gets 30% of their natural gas from Russia and saw natural gas prices surge 50% at one point. Energy prices had significantly moved up already from 2021 with US gasoline prices up 30%+ yoy. The increase in energy prices will be a drag on the global economy and negatively impact low to middle income earners the most with consumer spending on other goods likely to decrease along with consumer sentiment due to higher inflation. Truck and auto production could take a hit from the cost of palladium spiking and the potential for a decline in Russian exports of the metal (used in catalytic converters). Corn and wheat prices spiked as supplies from the region may be diminished. The spikes in commodity prices will add to global inflation and put additional pressure on the Federal Reserve to act more forcefully.
2. US hegemony and advocacy of democracy to decline should Putin be successful. Since World War II, the US has led the world as an advocate for democracy, capitalism and open markets. Through the US military, trade routes have remained free and unencumbered. All nations have benefited from global free trade, despite its many shortcomings. Yes, the US has made many foreign policy errors from Latin America to Iraq. Yet, the miracle of economic growth has lifted hundreds of millions of Chinese and Indians out of poverty including many in the former Soviet Union. Now, the world faces a potentially extremely different geopolitical and economic structure of totalitarianism. While many nations strained under US hegemony in the past, this new framework will likely create a rethink of the drawbacks under a democratically (republic) driven nation.
3. A successful Russian takeover will send a message to other nations that this can be done, and the new world order is one of aggression. This could translate into numerous actions across the political hot zones in the world. The friction between China and Taiwan should be of great concern as Taiwan has the world’s largest semiconductor company. A loss of chip output would likely cause a significant decline in the production of US autos. It would certainly curtain any notion of moving quickly from ICE engines to EV engines as these require twice the number of chips. In this vein, China may see the Russian invasion as an opportunity to exert military influence into its claim to the South China Sea and the outlying archipelagos. Philippines, Malaysia and Vietnam could all be potentially impacted. Finally, let’s not forget about North Korea.

7 Positives

1. The unification of NATO due to the threat of Russia. Here are the NATO countries: 30 NATO member countries: Albania, Belgium, Bulgaria, Canada, Croatia, Czech Republic, Denmark, Estonia, France, Germany, Greece, Hungary, Iceland, Italy, Latvia, Lithuania, Luxembourg, Montenegro, the Netherlands, North Macedonia, Norway, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Turkey, United Kingdom, United States. With the failure of NATO to adequately respond to Russia’s annexation of Crimea, this trans-Atlantic relationship needs to be fortified and activated. Due to COVID, many of these nations reduced their military spending and have not prioritized defense. As an example, Poland will now have two countries (assuming Ukraine invasion is successful) who are aligned with Russia on its border. Estonia, Latvia and Lithuania have already been living with this threat of invasion and should now increase defense spending. Every NATO member needs to address the paltry sums they committed to previously (2%!) and begin a process of rearmament. The threat of Russia and invasion is no longer theoretical, nor should it be seen as merely an exercise.
2. The US oil and gas industry will be supercharged under extended Russian sanctions and the shut-down of Russian natural gas to the EU. This sector had incredible investment from 2011-2019 but had just as large a poor return on that investment as oil prices fell. Since COVID and the drop of oil prices into negative territory, this sector has held the line on expansion. This much needed fiscal discipline helped companies survive, profit and encourage new developments. The Biden administration has been active in promoting oil development somewhat under the radar. In November, the US held the largest-ever auction of oil and gas drilling leases in the Gulf of Mexico, providing more than 80 million acres of possible fossil fuel development. As well, the Bureau of Land Management approved 511 permits for drilling from 10/1/21-11/30/21. From 10/1/2020-9/30/21, the BLM approved 5,145 permits. Baker Hughes oil rig counts have increased to 645 from 397 a year ago. The key to all of this would be for the US to wean the rest of the world away from Russian energy.
3. The drive to develop alternative energy will increase as EU nations experience shortages from Russian natural gas. It will be supercharged by Germany as they have phased out all coal and nuclear power plants. They will likely lead on the development of alt energy as they have made a grave mistake in quickly transitioning into dependence on Russia and green energy. Green energy simply cannot meet the need of global energy demand. Yet, the Russian invasion will drive a huge need or demand to speed up investment and innovation.
4. The Trans-Pacific Partnership trade agreement should see renewed interest to move forward as an offset to both Russia and China. Like NATO, the presence of an existential threat is a policy focusing event. According to the CFR, “The TPP was a massive trade agreement signed by twelve Pacific Rim countries, including the United States, that together comprised 40 percent of the global economy. While many experts say the TPP had economic and strategic benefits, it drew attacks from across the U.S. political spectrum. President Trump withdrew from the deal on his first day in office. The eleven other TPP countries have moved forward with a slightly modified agreement and have left the door open for the United States to rejoin.” China applied to join. While President Biden has not supported rejoining the TPP, his mind may change if China becomes more aggressive in the South China Sea.
5. A completion of the Iranian nuclear deal has the potential to bring needed oil back onto the markets. Given the discipline of OPEC/Russia/Saudi Arabia in holding down oil production, the world has seen a steady rise in prices prior to the invasion. Since the invasion, Saudi Arabia has been silent on increasing production to offset the impact and providing tacit approval to the incursion. Iran has no such allegiance and would likely be quite happy to throw a shoe at SA by pumping as much oil as possible. According to the IEA, a nuclear deal could bring back 1.3 mln barrels a day of Iranian oil.
6. The world has assumed a Russian victory, but should it? A protracted war in the Ukraine would undermine Russia and Putin both abroad and at home. This could have domestic political repercussions as protests would rise as deaths rise. It would be costly to maintain a force in the Ukraine and the Russian economy would suffer as sanctions bite over the longer term. Yes, Russia has done an excellent job of insulating their finances by dumping US dollar reserves and adding gold. But eventually, the Russian economy would be hurt and make it even more dependent on oil. A collapse in the Russian ruble will add to the Russian consumer misery.
7. The uncertainty and instability from the Russian invasion will likely slow the Federal Reserve tightening program. Given the recent increase in expectations for the number of rate hikes to between 7 and 9 plus quantitative tightening, the Fed will not likely act as aggressively to address inflation. Demand destruction from a spike in oil prices has the potential to slow the US economy and reduce demand driving overall prices higher. Fed rate hikes will eventually raise the price of money and reduce demand, but the central bank must be careful not to overdo it and cause a recession. This slower pace will stabilize equity markets and smooth a transition to a higher rate environment while giving the Fed cover to allow inflation to come down from its likely peak in Q1.

To be clear, the Russian invasion is causing casualties and forcibly taking over a sovereign nation. None of this is good for anyone.

Yet, this will set in motion many changes that may have a much better outcome than first perceived. It will be a question of how the Biden administration, Congress and our allies manage the challenge.