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Christopher J. Wolfe on the Russia-Ukraine War Impact on Economy: KGO Radio

 
February 28, 2022

Listen to Christopher J. Wolfe, Chief Investment Officer of First Republic Private Wealth Management, discuss how the Russia-Ukraine war will impact the economy and markets on KGO 810 AM Radio in San Francisco with host Mark Thompson.


Read below for a full transcript of the conversation.

Mark:
Chris, I want to ask you first about, and we’re gonna get to oil prices, but I want to ask you about this banking system as associated with many of the sanctions that have been both produced and been talked about. One of the things that’s been held out, and this I’d always thought that this is sort of a third rail thing, but you can let me know whether that’s true or not. And that’s the SWIFT, um, this banking financial connection that is held worldwide, where banking institutions essentially communicate on transactions across this network. And the reason I say I’d always thought it was a third rail is because of the, uh, if there are energy transfers being made, that is to say if Russia is still supplying natural gas to the EU, which they are, those transactions for that natural gas, those have to take place across that same financial system. Don’t they?

Chris:
Yeah, in concept they do; that is correct. The system is called SWIFT. And what I think most people have done is they’ve looked at what happened to Iran, when the United States and others cut them off. And it was a pretty damaging set of effects to the Iranian economy. I think they applied that model and said, “That’s gonna happen to Russia.” And the reality is something different seems to be evolving there: whether it’s more limited cutoffs, meaning certain parts of the Russian banking system, not the entirety of the banking system in Russia. Um, there are other workarounds with respect to how, um, transfers of money and payments are made. Uh, the president at one point had said that we might exclude energy payments and transfers, because that is a very large portion of any kind of money coming into Russia.

Chris:
So, it’s not completely decided yet. And then the other piece of that puzzle, at least with respect to SWIFT, the other piece of that puzzle is the other linkages that Russian banks have to European banks. So this is a little bit like a sieve and while SWIFT is the most important, you can plug up a lot of the holes in the sieve. You may not be able to get them all, and they seem intent on leaving some open. So I would say that we don’t want to draw, um, extreme conclusions, just yet.

Mark:
It’s interesting, even in your or answer, I get that, you know, the relationships are so intricate worldwide. I mean, this isn’t an old-world thing. You see how we are all linked. Yet this is such an old-world way of dominating a region: to go in and grab the land. I mean, it’s really a, you know, it’s a turn-of-the-last-century kind of move that Putin’s made. And yet the sanctions have to reflect the sort of new technology and relationships that exist in contemporary finance.

Chris:
That is absolutely true. And, you know, the challenge when you do things like that is that there’s always consequences and repercussions. And what I think Mr. Putin has shown is that, uh, there is a willingness to go beyond whatever lines the West may or may not have drawn, even if they’re 10 or 15 or 20 or 30 years old. The challenge around what I think is happening currently is that there are consequences, at least from an investor’s perspective, that are going to be real. And they’re going to be felt not just for the moment or the week, but likely for months and potentially for years.

Mark:
Well, let’s talk about that. Then how will those things be felt? I mean, for example.

Chris:
So I think the easiest one to talk about is energy markets. Right now Russia is a very large, well they were until recently, a large exporter of energy products, mostly to Europe. Almost half of their exports in terms of oil and natural gas go to Europe. That’s gonna be slowing down. So one of the things that has happened as a result of Russia’s invasion of Ukraine is it will likely speed up the demand for things like electric vehicles. It will speed up Europe’s approach to how they think about electric vehicles. So as to reduce dependence upon Russian oil. You in fact saw Germany’s chancellor announce that they’ll be building, uh, or actually adding to their liquified natural gas terminals, so they can get more gas, for example, from Qatar and Kuwait and other places. And while that’s not, uh, a singular solution (replace Russian energy with Kuwaiti or Qatar energy), it’s much more about the direction that the economies are taking.

Chris:
And if you think about the big picture here, this really amounts to economic ostracism, what’s happening with Russia. And that’s gonna have the consequences on energy, where if you take some of the supply out of the market, it’s likely to keep energy prices higher, longer than normal. Um, and our view is that for a U.S. investor, a U.S. consumer, you’re gonna see gas prices higher at the pump for a longer period of time. In California, that could mean $6, $7 gas on a more regular basis across the state, uh, you know, over the next several months, not just the next several weeks.

Mark:
That’s an extraordinary notion. We’re talking to Christopher J. Wolfe. He’s the Wolfe of San Francisco, Chief Investment Officer of First Republic Private Wealth Management based in the city. I wonder then if those things come to pass, which I have no reason to believe they wouldn’t. I mean, as you say, as there’s a constriction in supply, and you have all that consistent demand, the prices go up along the lines of what you’ve suggested. That’s going to affect the economy across the board domestically and across the world. Energy’s gonna become more expensive, and those energy costs affect that entire supply chain we’ve heard so much about.

Speaker 2:
A hundred percent, Mark. A hundred percent. So here’s the three things. The simple economist answer is that higher energy prices act like a tax on everybody. And they actually tax those in the lower incomes the most, kind of simply put. Number two is energy is used in the processing of food. So food prices will probably be higher as well. We gotta process food, store it, move it, get it from one place to another, and that requires energy, right? Trucking is an example. I think the last piece around the energy story is, if you’re looking at the U.S. domestic energy production, you know, the Permian Basin or the Bakken Shale in North Dakota, what we’re seeing is that the utilization of energy equipment and people is already very high. The U.S. shale industry just can’t turn things up fast enough to solve all of this. So I think you’re gonna get a lot more political noise to kind of turn on U.S. production. That’s not necessarily a bad thing. But we’re gonna be talking about a U.S. market that’s gonna have to weather higher oil prices, at least through the summer.

Mark:
Aren’t the higher oil prices, something that the Middle Eastern countries, for example (since they’re the next big sweet spot, I would think), uh, aren’t they happy about the higher oil prices? I mean, we keep looking to, you know, grab the phone and ask the Saudis to increase production. The reality is they’re happy with the prices higher.

Chris:
Yeah. You know, from an economic perspective, the Saudi government would like high oil prices to help balance their budget. That’s important, uh, for their economy, for the well-being of their people. But the reality about kind of happy or not, you know, I think there is nothing if not a sensitivity in the Middle East to the geopolitical consequences for oil prices too high and the demand destruction, and then the choices that get made by industry participants when oil prices are too high. In some ways, the lesson of oil prices too high got us the shale revolution in the U.S. And, I think the Middle Eastern players are not super keen on revisiting that: where the control of the marginal barrel of oil moves away from the Middle East and back to the U.S. Right now, we’re in a place where (I think to your question, Mark), yes, they are “happy” (in quotes). But the reality is I think there is an opportunity that we will see come about over the summer for the Middle East to step in with respect to how energy prices play out.

Chris:
And that’s part of our belief that energy prices shouldn’t be kind of cresting, you know, anything north of 120 this year, uh, and may come down as the year evolves. Growing U.S. production and, I think, the Middle East stepping up is an opportunity for us not to get concerned that oil’s headed to $200 a barrel (I don’t think that’s the case) and that gas is going to 10 (don’t think that’s the case either). But we’re gonna deal with some pressure now and some relief later.

Mark:
Wow. Christopher J. Wolfe who handles, uh well, he’s the Chief Investment Officer First Republic Private Wealth Management. I mean, there’s all that money moving in different places. And it’s funny, I’ve just gotten a text, and I did want to ask you this before these tensions broke out, to be polite about it, war broke out in Ukraine, Clyde in the 408 wants to know how will cryptocurrency come into play? And before you answer, you know, Chris, I mentioned that crypto is increasingly a place where a lot of these oligarchs can hide their money and actually evade a lot of these sanctioning provisions that we are seeing. Now, this all kind of happened. I don’t know that they were able to dump all their money there, but what I’m saying is it’s increasingly an area in which these oligarchs, of whom there are, you know, a handful there in Russia running the show, are able to hide a lot of money. Isn’t that the case?

Chris:
Well, I think some of the reports by the U.S. government have indicated as much: that the challenges around crypto indicate that they can be used for nefarious means. I think it would be difficult if you’re a Russian oligarch to just transfer all your money and wealth into, say, Bitcoin or Ethereum. I think that’s actually quite difficult. And with changes to the banking system we discussed earlier, say, removal from SWIFT, it may create an incentive for the oligarchs to do that. But I think the reality is it’s very hard. It’s not that liquid. I don’t know if you’ve ever tried pay for your groceries in Ethereum. Yeah, can’t do it. And certainly not gonna be able to do it in Russia. So I think the answer to that question is actually quite complicated. You know, crypto, you know, I think is gonna be buffeted by other factors, higher interest rates in the United States, the cost of other money going up, as an example, I think we’re gonna see that affect crypto prices.

Chris:
Crypto’s not all that liquid either. We still see the big swings in the markets here You know, and other alternatives like gold have actually started to, you know, perk up a bit. Gold prices have come up quite a bit. And in some ways that’s a little bit like the last currency that, uh, anybody would look at. Russia, in fact, started buying more gold recently or they’ve indicated as much. So, I think there are other alternatives, and I don’t think all of the relief that an oligarch would want is gonna come through buying cryptocurrency. I just don’t see it.

Mark:
Last question for you is about the markets. We’ve seen them, of course, crater early in the week, last week, and then rally insanely at the end of last week. Now it would appear they’re headed down again. This is because of what investors like yourself really don’t like, which is, an unpredictable situation, right? The fragility of everything has made the market skittish?

Chris:
Yeah, I think that is in large measure, one of the best explanations. It’s you, you’ve had a very long bull market for a very long period of time. You know, the current geopolitical situation is not anything like we’ve seen in a while. Uh, so you’re gonna get a premium, uh, built into, you know, risky assets like stocks. That sounds a lot like, well, the prices have to come down to reflect all of the risk that’s there. You know, if you look back five days though, the market’s only down just a little bit, just 1-2%, bond yields are down 10 basis points. The biggest change has been in commodity markets (energy, metals and agricultural commodities) in just the last five days. So, you know, I think a lot of folks had anticipated this in some ways, were either, you know, not as exposed to Russia (I know our clients aren’t) or not exposed even to kind of broadly emerging markets.

Chris:
And, that meant that there’s relative insulation. You know, a balanced portfolio year to date is only down a couple percent, despite all the volatility. And I think that’s what happens is investors look at their statement at the end of the month and go, “Okay, I got it. I’m not down that much. I can weather this storm.” So even though there’s been a lot of noise, I don’t sense that there’s an investor panic at the moment. This is a lot of institutional money, uh, kind of moving around with algorithms, and lots of options and hedging trades trying to speculate on the direction of what Russia will do next. And, you know, for a long-term investor, like our clients, that’s a fool’s errand.

Mark:
Yeah. And it’s sort of sound financial advice. Such a great mind on the market, such a great mind on the economy: Great to have him in the city. He is the Wolfe of San Francisco, Christopher J. Wolfe. Thank you. He’s the Chief Investment Officer of First Republic Private Wealth Management based in the city. Thanks, Chris.

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