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11 May 2022

THE ECONOMIC EFFECTS OF WAR

Russia’s invasion of Ukraine strikes us as one of the most-expected unexpected events of recent times. Steeped in a revisionist ideal of Russian identity, President Putin is rattling the cage of the current world order. NICK CURTIN writes about the inflationary pressures that result from the war.

It is difficult to feign surprise at Russia’s invasion of Ukraine. We have for some time flagged escalating geopolitical risks, ranging from the US-China trade wars, Brexit, the China-Taiwan conundrum, Russian insecurities over NATO expansion, ongoing conflict in the Middle East and general schizophrenia in the EU. We even flag the alarming internal political divide in the US as having potentially global geopolitical consequences in the fullness of time.

These dynamics are in fact intricately connected. Nonetheless, the physical outbreak of war with all its concomitant horrors not only disturbs our human sensibilities but disrupts financial markets — especially so when the protagonists are central to the world’s energy and food production industries. Well-trodden, although largely dormant, geopolitical fault-lines between east and west further complicate matters.

The consequences of war manifest through several channels; the most immediate being via increased market volatility. Volatility results as participants begin to calibrate the initial extent of the conflict and the various permutations for potential escalation. Companies and industries with operations in the geographical area of conflict attract the quickest market adjustments.

Broader ramifications take longer to assert as unintended consequences start to emerge — the most obvious of which in the current Russia-Ukraine war are the energy markets. Russia is a key producer and exporter of oil — and especially natural gas — to large parts of the EU. Since fuel is a key input cost to the production and transport of goods, the effect of surging energy prices on rising global inflation expectations has been swift.

Russia and Ukraine collectively produce around one third of the world’s wheat, making up more than a quarter of global wheat exports. Grains are a key ingredient in the global food production chain. The prospect of significant medium-term supply shortfalls caused wheat and other agricultural commodity prices to surge.

Russia and neighbouring ally Belarus are also key participants in the production of fertiliser needed to maintain global crop yields. In time, higher grain prices, compounded by higher energy and fertiliser costs, should lead to higher food prices. In some instances, outright scarcity could result. There could also be serious socio-political consequences in poorer countries, where the economic vulnerabilities to food shortages and inflation could be catastrophic.

If there is any positive for Foord investors to the outbreak of conventional warfare in Europe, it is that the Foord funds were well positioned for the consequences of just such an escalation. The Foord portfolios also had a good amount of hedging to higher energy and agricultural commodity related prices, and no direct exposure to the region.

While unexpected risk events are psychologically uncomfortable for investors, Foord’s portfolio managers relish the opportunities that the attendant market volatility usually dishes up. This is where we are concentrating our focus.

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