Lower inflationary expectations
Given the context, we expect the primary effect to be in bond yield curves- we expect a shift down in the yield curve and lower inflationary expectations.
Inflationary expectations (conventional yield- inflation index linked yield) have remained elevated since 24th February 2022. This is due to rising global consumer price inflation in particular for food and energy but also for services and wages. In fact, the emergence of high inflation in the services side of the US economy is the major differentiator in 2022; service sector inflation has moved from 4.5% in January 2022 to almost 7.4% in October 2022. Usually service sector inflation significantly lags commodities price inflation.
US Federal Funds rate now stand at 4% (we expect a further hike to 4.5% on 14th December 2022) having begun the year at 0.08% – one of the sharpest moves ever. This has led to the worst year for US Treasuries since records began. However, interest rate hikes should moderate and peak over 2023.
The current US bond yield has shifted upwards over 2022 but has lowered in the last month. The largest movement has been in the short end of the curve. Our broad expectation would be a for a downward shift in the yield curve in the event of an end of the Russia/ Ukraine war.
A full reversal back to normal prices for soft commodity will depend on Ukraine’s port/sea access and other factors including fully functioning infrastructure (grain silos/ labour availability, power) however assuming these factors are sufficient, we expect soft commodities to continue recent lower trends:-
Wheat prices have calmed considerably since May 2022 reversing c.$420 due to rising production. Recent US Dept of Agriculture (USDA) data estimates that for 2023 all wheat planted area was 47.5m +1.8m (+3.9%) with average yield of 49.2 bushels / acre up 6%. Total wheat production in FY23 is expected at c. 1.92bn bushels +269m or 16% – the highest level since 2019, potentially leading to oversupply conditions.
Given the rising oversupply position, the end of the Russia/ Ukraine war could lead to further supplies and hence lower prices possibly to $600 i.e. the position in September 2020.
Corn has likewise increased its harvest space. In 2023 it is expected to be 92m acres+3.4m acres (+3.8%). Corn production is expected at 15.26bn with average yield of 181.5bn bushels +5.6%. An end to hostilities could lead to larger adjustment in corn possibly to $500.
Soybean pricing has remained high rising from $13/ bushel to $14.85/ bushel and remaining firm and range bound for 2022. There is a high expectation for c. 48% that prices will remain in this range and a 24% chance of prices returning to $13/ bushel assuming the ending of tensions.
The Russia/Ukraine war has provided many talking points for the global defence sector. Broadly the war has updated everyone on modern warfare and countered pre-conceived notions.
Who has benefited from the war? in terms of manufactured goods:-
a) Mobile missile systems – HIMARS is one example
b) Satellite systems – the reconnaissance/spy satellites that provide very clear data on troop and artillery movements
c) Drone and unmanned aerial warfare systems
Who has not?
a) Tanks and slow-moving battlefield vehicles such as taxis.
b) Large naval frigates, aircraft carriers, destroyers
c) Helicopters, large airborne carriers
This product mix presents challenges for the traditional defence contractors predicting demand trends and future procurement. It is a complex demand picture that will going forward will accommodate EU army procurement (eventually), NATO expansion and increased defence budgets – but will also impact non-traditional defence areas. Overall the impact could well be slightly negative for BAE Systems, Lockheed, Northrop, Thales and Boeing. It will benefit niche specialists particularly in unmanned aircraft.
Global index move likely positive
The end of the war/peace dividend when it arrives, will be clearly positive for leading indices and the short- term path of global interest rates. We are confident the Russia/Ukraine conflict will end in 2023 and be largely determined by battlefield developments. Rather like the 1991 Gulf War, I would be surprised if Russia’s defeat leads to the departure of President Vladimir Putin though it might.
An improvement in MSCI World Index of c. 5% would be our baseline expectation. As of end November the index is down 14.12% a performance that fairly prices the magnitude of 2022.