Grandstand. Financial markets had already become volatile at the start of the year, with investors reassessing the prospects for higher inflation and a tightening of monetary policy by the Federal Reserve (Fed).
Today, the consequences of Russia’s invasion of Ukraine and the response that may emanate from the United States and NATO only increase the uncertainties, as well as a sharp drop in the stock markets global.
Quadrupling of prices
While no one can be sure what turn of events will take, history shows that with every geopolitical conflict, financial markets react the most when energy prices soar and the Fed and other banks central banks are tightening their monetary policy.
These lessons have been learned from the first two oil shocks.
The first outbreak took place in 1973, when OPEC imposed an oil embargo on the United States in retaliation for the latter supplying arms to Israel during the Arab-Israeli conflict.
The second began in early 1979, when the Shah of Iran was overthrown and Iran’s oil production fell from 5.2 million barrels per day (mb/d) to just 1.4 Mb/d in 1980, thus eliminating 6% of world production.
In both cases, oil prices quadrupled and the Federal Reserve dramatically raised interest rates to counter the impact of rising inflation. This resulted in the sharp rise in bond yields and stock market sales that accompanied the severe recessions of 1973-74 and 1982-83.
Inflation under control
In comparison, the subsequent increases in oil prices linked to the conflicts between the United States and Iraq in 1990 and 2003 had lesser repercussions on the economy and the markets.
This is explained, in particular, by the fact that the oil supply deficit was not as great as during the first two shocks and that price increases were lower.
In addition, the Federal Reserve did not tighten monetary policy on both occasions as inflation was under control. In this context, the Fed viewed rising oil prices as a tax on households and businesses that would weaken the economy.
In view of these considerations, the main questions investors are now asking are: what consequences can Russia’s invasion of Ukraine have on the energy markets? And how will the outcome affect US monetary policy?
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