Why Russia and Ukraine Matter to the Stock Market

If you’re wondering why what is going on in Russia and Ukraine matters to the stock market, we’re here to help.

Stocks have been under pressure, falling into correction territory this week as tensions mounted and Russia launched a major military invasion of Ukraine. Because Russia is one of the world’s largest producers of oil and global supplies are already low, investors are concerned the war could drive up the price, already at an 8-year high, fueling inflation and impeding economic growth.

The Russian assault on Ukraine was widespread, with attacks on Kyiv, Ukraine’s capital, and other major cities throughout the country. In response, the U.S. announced broad economic sanctions against Russia, including restrictions on banking, adding to sanctions imposed earlier in the week by the U.S., the U.K. and other western countries. Germany had cut off negotiations on a key natural gas pipeline linking Russia and Germany. 

The current conflict between Russia and Ukraine centers around two separatist regions in eastern Ukraine in an area called the Donbas. Pro-Russian rebels have been fighting Ukrainian forces in these two regions, the Donetsk People’s Republic and the Luhansk People’s Republic, for years. On Monday, Russian President Vladimir Putin declared Donetsk and Luhansk “independent” states and began moving Russian troops into the area, calling the troops “peacekeepers.”

Putin, who has long believed Ukraine should be part of Russia, began aggressively amassing troops at Russia’s border with Ukraine late last year, but the conflict dates back at least to 2014, when Russia annexed Crimea, a peninsula in the Black Sea with a majority Russian population, from Ukraine. Putin also opposes Ukraine’s ties to the West and its interest in joining the North Atlantic Treaty Organization and the European Union.

The war between Russia and Ukraine could have serious implications for the world economy, although how deep and long-lasting they would be is unclear.

“The economic and market consequences of a war between Russia and Ukraine will depend on the severity of the conflict, and the response of the West,” wrote Neil Shearing, group chief economist at Capital Economics, in a commentary on Tuesday. “But in most cases the economic impact on countries beyond Russia and Ukraine is likely to be limited.”

The Biggest Risk Involves Oil

The biggest risk involves oil and its effect on inflation. Because of the importance of Russian oil to the world economy, any situation that would limit its supply could cause prices, which are already up more than 40% since December, to go up even more.

The cost of a barrel of oil was high even before the Russian invasion of Ukraine because of an imbalance between supply and demand. On the supply side, OPEC+ (the Organization of the Petroleum Exporting Countries and other oil-producing countries) has been limiting production and keeping inventories low. And on the demand side, cold weather, an increase in travel, and strong consumer spending have pumped up the use of energy to heat our homes, fuel our cars, and ship our stuff.

A barrel of Brent crude oil was trading around $97 on Wednesday, the day before the invasion. On Thursday, after the news of Russia’s assault on Ukraine broke, it traded as high as $105 before dropping again later in the day.

Higher oil prices in turn lead to higher prices for just about everything else. Inflation was already running at 7.5% in January,  a 40-year high, and it’s been driven in large part by increases in the cost of energy. A gallon of regular unleaded gas cost $3.54 Thursday, up more than 34% since last year at this time. Oil makes up about half the price of a gallon of gas, and nearly everything in the economy has to be transported by planes, ships, trains, trucks, or other vehicles that use gas or other fuel. That adds to the cost of goods and services. 

All this could have an impact on economic growth as well.

A $10 rise in crude oil prices has traditionally shaved U.S. GDP growth by about 0.1 percentage points, researchers at BMO Capital Markets Economics said in a report.  

Shearing of Capital Economics estimates that in a worst-case scenario, oil prices could rise to between $120 and $140 per barrel, which would add an additional two percentage points to inflation in advanced economies.

“In normal times, central banks would tend to look through an energy-led rise in inflation, but given the current high rates of inflation, and corresponding concerns about it feeding higher inflation expectations, it’s possible that this adds to the list of reasons for policymakers to raise interest rates,” he said.

As difficult as it may be to watch the markets gyrate each day, take some solace in the fact that, for now, most market analysts don’t expect the Russia-Ukraine conflict to sink your portfolio. 

The original version of this story was published on Feb. 23, 2022.

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