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U.S. equities slid lower last week and remain under pressure this week as mounting concerns of conflict in Ukraine have pushed investors toward safe haven assets. The S&P 500 slid 1.6% lower last week and has fallen into correction territory this week as the index is now down over 10% below its high. Geopolitical fears have halted the sharp recent rise in interest rates as more investors have sought the safety of bonds and pushed long-term rates lower with the 10-year Treasury yield falling to 1.93% after reaching as high as 2.05% on Wednesday of last week. Precious metals are also seeing greater demand as gold prices jumped over 3% higher last week.

The situation in Ukraine continues to evolve rapidly. Russia wasted no time following the conclusion of the Beijing Winter Olympics on Sunday, with President Vladimir Putin signing an order on Monday recognizing two breakaway, separatist-controlled regions in eastern Ukraine, the Donetsk and Luhansk People’s Republics, and ordering Russian troops into the regions for “peacekeeping” operations.

In response, the White House has called the move the beginning of an invasion, and they have unveiled the first round of economic sanctions targeting Russian financial institutions, its sovereign debt, and Russian elites and their family members. The European Union and U.K. have followed suit with similar targeted sanctions. Each administration has vowed to ramp up economic sanctions considerably if Russia continues to escalate its actions toward a full-scale invasion.

While U.S. companies have limited direct exposure to Russia and Ukraine (S&P 500 constituents in aggregate generate less than 1% of revenue from Russia and Ukraine according to FactSet), one of the primary economic risks that we are watching is the potential disruption to key commodity markets, particularly energy. In response to the Kremlin’s recent push into eastern Ukraine, German Chancellor Olaf Scholz has announced that Germany is halting certification of the Nord Stream 2, an $11 billion natural gas pipeline from Russia that completed construction late last year. Natural gas prices spiked nearly 10% last week as Russia is a key supplier of natural gas to Europe and Brent crude oil prices have edged closer to $100 per barrel.

A sustained spike in energy costs from these disruptions would worsen current inflationary pressures, further complicating the path ahead for central banks, whose hands are already being forced to move swiftly toward tightening. Hiking interest rates are a means to reining in excess demand that may help fuel inflation, but they do not address supply side issues like pandemic lockdowns or energy shocks from geopolitical conflict. The potential for counter-measures to economic sanctions on Russia, including cyberwarfare, is also a risk that investors will be monitoring.

At this point the potential of an escalation toward a full-scale invasion and conflict is unclear as Western officials continue to push diplomatic efforts. As the situation in Ukraine develops and central banks push toward policy normalization, our team will continue to keep you apprised of the implications for financial markets and our thoughts on navigating these risks. Please don’t hesitate to reach out to your First Merchants Private Wealth advisor if you have questions or concerns.