While the world's attention was on Ukraine, the S&P500 opened substantially lower yesterday. While it managed to eke back some of its losses through the trading session, it’s still technically in correction territory.

Of course, the idea of a correction is that there will be a subsequent bounce back, and the market will move higher. However, given the current climate of uncertainty, and particularly the underlying economic data, that bounce back might not be as vigorous.

More to the point, the global implications of the Ukraine crisis might lead to the Fed recalibrating their outlook. Or at least maybe the market will reconsider its 7 to 8 hikes this year.

What does it mean?

The Nasdaq has already fallen into correction, mostly dragged down by tech stocks. That happened well before the start of the Ukraine situation, as traders were moving from the more speculative stocks towards growth stocks as the pandemic was coming to an end. The S&P 500 also has a large amount of tech stocks, though not as much as the Nasdaq.

These stocks have high valuations, making them more attractive to investors with leverage. As interest rates go up with the Fed fighting inflation, it’s less profitable to invest in tech stocks.

That's a very summarized version, of course.

The point is that what's weight on the S&P primarily is a move away from higher valuations. The relative exposure to the conflict in Ukraine directly from US companies is relatively small.

It's an inflation problem

Along with the Ukraine crisis, there was a spike in oil prices. Depending on the kind of sanctions that are applied, and the extension of the conflict, crude prices could remain elevated for some time.

That could eventually filter through to create more inflation. In fact, this would presumably make the Fed more likely to raise rates.

However, the increased costs would also likely have an impact on the economy, as American's dollars buy increasingly less stuff. With fuel prices potentially eating more disposable income, discretionary consumption could come under renewed pressure. And this would slow down the economy.

The sanctions problem

The other issue is that even relatively minor sanctions on Russia could have unexpected economic effects.

Russia is a very big country, and depending on how the war goes, sanctions would also potentially apply to Ukrainian territory as well. Russia is a major producer of many key elements that are already in short supply, such as palladium, and the supply of neon, which is essential for the manufacture of semiconductors.

If investors are concerned about the potential fallout of the conflict, then we could see the velocity of money slowing down.

That could help the Fed in contributing to lower inflation. On the other hand, that would also mean it's less likely for the Fed to raise rates as aggressively.

Where things could go

The risk-off sentiment could keep the dollar stronger. And in turn, it would help reduce the cost of imported products. That’s another factor that could also contribute to lowering inflation expectations.

This doesn't really mean that we should reconsider a rate hike at the next Fed meeting.

However, over the next couple of weeks, depending on how the Ukraine situation goes, we might see a change in overall risk appetite. That said, this could lead to a recalibration of how hawkish the Fed could be.

If policy is expected to be less tight, then the correction might just be an indication for a rebound. Nonetheless, that assumes that inflation will be aided by a more cautious economic approach. And that might depend a lot on what degree and type of sanctions the West ultimately decides to levy on Russia.

This article was submitted by Orbex.