What a difference a week and a war make. As we have written before, if a disunited West was powerless and dysfunctional at preventing Vladimir Putin’s invasion of Ukraine, late in the day it is now showing some sense of purpose, mettle and solidity with its sanctions regime, even if Sleepy Joe’s State of the Union speech was as inspiring as a tepid rice pudding and his confusing Ukrainians with Iranians another of his brain-free moments best forgotten.

Germany gets a grip on reality

Germany! Germany has undergone a Damascene conversion in only a few days. Having been in Russia’s pocket and cast as the arch appeaser of Moscow in the NATO camp, the criticism of Berlin peppered with a sharp confrontation with reality clearly prompted some deep and very rapid Germanic soul-searching about whose side they’re on.

 

As if a bursting soap bubble, 16 years of ‘Merkelism’ popped and vanished in an afternoon. Her legacy of middle-of-the-road compromising with Moscow, partly with the aim of generating political leverage over Putin, was laid waste. That it came from the left-leaning leader of her former junior coalition partner, the SPD, made it all the more remarkable.  Last Saturday in a keynote speech to the Bundestag, Chancellor Scholz slayed so many of Germany’s taboos in one fell swoop: €100bn of additional expenditure earmarked for significant re-armament and restoring Germany’s defence forces; an immediate relaxation of the constitution, lifting the sales embargo on German-made weapons and military systems to an active war zone, in the case of Ukraine with the result that 1,000 German-made anti-tank weapons and 500 hand-held Stinger anti-aircraft missiles will be sent; and, in the light of the shelving of Nord Stream 2 and the obvious unsustainability of his new government’s energy policy (see our previous article: ‘Is Germany’s energy policy unravelling?’), relaxing the datelines for (if not completely ditching the commitment to) the phasing out of nuclear and fossil-fuel energy. It is a seismic shift in German foreign and energy policies.

Commodities on speed
141 countries voted to condemn Russia in this week’s UN resolution, demanding an immediate withdrawal from Ukraine. Four supported Russia: Belarus predictably, together with Syria, North Korea and Eritrea. Even Putin’s allies including China, Cuba and Nicaragua joined 32 others in abstaining.

As the war progresses and Russia becomes more economically and politically isolated, the wider effects upon the rest of the world are immediately obvious. Russian assets (those still legally tradable) are heavily discounted if you can get a price at all. Most are essentially worthless. Commodity prices have reacted sharply, even though there are as yet no sanctions on the sale of Russian oil and gas (though many buyers and intermediaries have backed away in principle while others who might still like to buy are worried about the mechanics of trading in an environment in which Russian banks being suspended from SWIFT is the determining factor). At the time of writing, Brent oil has spiked to $115 per barrel, nearly double its price 12 months ago, and $25 per barrel higher than the day before the invasion. Volatile gas prices are up multiples on a year ago, and in the UK, up 50% this week. The price of wheat at $11.23 per bushel is up 39% against ten days ago, has risen 72% on this time last year and is 123% higher than this time two years ago; the latest wheat price spike is having a knock-on effect on markets such as soya, even though neither Russia nor Ukraine is a major producer.

The looming spectre of stagflation

All of this is feeding into global inflation rates. If the major central banks were preoccupied with rising prices before the conflict and market expectations of tougher monetary policy had been brought forward by at least 18 months, particularly against the US Federal Reserve’s narrative as recently as last autumn (‘inflation? Nothing to see here! Move on, guys. Move on!’), now it presents a real headache. ‘Stagflation’ – stagnant economic growth combined with inflation – is rearing its ugly head as more than a possibility. Economists are sharpening their pencils and cleaning their rubbers in anticipation of reducing their economic growth forecasts. Some are even raising the possibility of the global economy heading towards recession next year. And yet major input costs are steaming upwards, feeding the inflation beast, partly as a hangover from the pandemic dislocation but significantly exacerbated by the Ukrainian crisis. Against such a febrile backdrop it is impossible to say when prices will stabilise and/or whether they reverse sharply afterwards.

 

The monetary policy committees of the European Central Bank (10th March), the US Federal Reserve (15th March) and the Bank of England (17th March) meet this month. Before Ukraine, when markets were almost entirely preoccupied with inflation and central bank policy (it will be the job of economic historians to ponder how, right up until the hour his forces marched in, markets discounted the possibility of Putin invading Ukraine as vanishingly small), it was assumed that the Fed and the Bank of England would adopt a robust and aggressive stance on interest rates for the whole of 2022. While it is still assumed that both will raise interest rates this month (according to Bloomberg, ‘priced in’ as 100% certain, and a speech by Fed Chairman Jay Powell this week effectively intimated as much) and up until mid-year, the odds on further interest rate rises in the second half lengthen quite sharply. Given current events were part of barely anyone’s script as recently as six months ago, having confidence in estimates six months on from here is not something any sensible person would bet the ranch on. But at least it provides an indication of the base case assumptions from which markets would be changing their perspectives as events unfold.

 

The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each.  With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions.

Could Putin turn off the gas tap?

The most immediate question is what if Putin decides to retaliate against Germany’s decision to freeze NS2 by closing off all gas supplies, not only to Germany but to the rest of the EU too? President Biden has been clear that the western allies, already facing significant inflation pressures many of which arise from energy prices that were escalating even before Putin invaded Ukraine, have no intention so far of placing sanctions on Russian oil and gas exports in order to maintain ‘orderly’ global energy markets.

 

However, as has been demonstrated, Putin has no such scruples about wider global responsibilities. Every decision he takes is purely through the Russian lens (more accurately, it is purely though his lens). With only a couple of months’ worth of gas storage capacity in Europe, he knows that he would leave many countries in the EU with significant headaches about how literally to keep the lights on and their industrial wheels turning (much as the problem faced by China in the second half of last year when it ran out of coal leading to swathes of industrial capacity having to be taken off-line in rotation to preserve fuel stocks); at what point would European popular opinion say, “enough! Give him what he wants!”. For Putin, his is purely a strategic decision based on how long he can incur the economic pain from the loss of income from gas and oil sales to Europe while finding alternative markets for his products.

 

As for Germany’s long-term future, there are some hard choices to be made now as it is confronted by the reality of its strategic reliance on imported energy, and what energy it produces domestically in a post-fossil fuel paradigm being neither reliable nor constant. If the strategy struggled to stack up before, in the light of current events it stacks up even less. It simply does not seem a realistic target to be trying to run a large, modern, industrialised economy, particularly one such as Germany’s which has the additional burden of being the lynchpin of the eurozone’s economic and financial system, based largely on sunshine and windmills.

 

The Jupiter Merlin Portfolios are long-term investments; they are certainly not immune from market volatility, but they are expected to be less volatile over time, commensurate with the risk tolerance of each. With liquidity uppermost in our mind, we seek to invest in funds run by experienced managers with a blend of styles but who share our core philosophy of trying to capture good performance in buoyant markets while minimising as far as possible the risk of losses in more challenging conditions.

The value of active minds – independent thinking

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