While the geopolitical impact of Russia’s incursion into Ukraine will play out in the weeks and months ahead, the economic impact has already been felt. The prices of energy and food, given that Russia is a large supplier of both, have spiked. Europe is particularly dependent on Russia for energy. It gets 40% of its natural gas and 25% of its oil from Russia.1 Russia is also the world’s largest supplier of wheat, and many countries, including those outside Europe like Lebanon and Egypt, depend on both Russia and Ukraine for much of their wheat.
As part of the West’s commitment to imposing sanctions against Russia for its actions, German Chancellor Olaf Scholz has announced a delay in the certification of the Nord Stream 2 pipeline that would have brought natural gas directly from Russia to Europe.2 The continent may now face energy shortages as well as higher prices. The United States has already increased its delivery of liquefied natural gas to the region and asked other countries, like Qatar, to do the same.3 Over the long run, Europe will have to diversify its sources of energy, and that will likely further hurt Russia’s economy if and when this conflict is resolved.
The crisis exacerbates the challenges the global economy is facing as it looks to emerge from the pandemic and many countries, like the United States, face already-high inflation. The heightened tensions in Ukraine will affect all the sectors in which Russia is a major exporter – including metals, as well as energy and food – and those price increases will have spillover effects on other sectors. Still, the situation would be much worse if Russia had a large economy or was a major global player, like China, across multiple sectors. Even though Russia’s military power is formidable, its role in the global economy is still relatively minor. As The New York Times notes, Italy’s economy is double the size of Russia’s, and Poland exports more goods to Europe than Russia does.4 Given that, the overall global impact of Russia becoming isolated through sanctions may be relatively contained.
While U.S. stocks did decline on the news of the invasion, the market did quickly rebound, reacting favorably to the sanctions the Biden Administration imposed. The immediate drop may have been a clearing event to take account for the present risks, and the market may now be ready to move past any panicked response. If current events don’t bring a full-on recession, stock valuations now low look relatively cheap. The greatest risk for global markets in the months ahead will be what degree of impact the crisis has on energy prices and whether Russia’s actions motivate China to take similar action against Taiwan.
Fed might hike rates seven times this year
Inflation soared in January, as the Consumer Price Index (CPI) posted a 7.5% annual gain, the highest pace of price increases in 40 years.5 That could lead the U.S. Federal Reserve to be even more aggressive in raising interest rates this year. Federal Reserve Bank of St. Louis President James Bullard even said the Fed may need to go past its neutral target interest rate of about 2% to put downward pressure on inflation.6 While he immediately attempted to soften those comments, there are expectations that the Fed could raise rates as many as seven times this year, perhaps opting for 0.25 basis point increases at each of this year’s seven remaining Federal Open Market Committee meetings.
The Producer Price Index also rose 1.3% in January, posting its biggest gain since 2009.7 The market seemed to shrug that news off, perhaps getting inured to the constant reports of higher inflation. There may also be some signs that inflation may be plateauing, or even getting ready to decline. Used car prices dropped in the first two weeks of February. While prices, as measured by the Mannheim Index, are still a whopping 38% higher than they were in February 2021, the prices of used cars did decline 1.5% in early February.8 We expect the across-the-board price hikes may peak with the next one or two inflation prints. By early spring, the CPI numbers reported each month may no longer be reaching highs not seen in decades.
The Russian action in Ukraine could also cause the Fed to make fewer hikes than have been anticipated. Federal Reserve Bank of Richmond President Tom Barkin on February 24 said the rationale for the rate hikes were the facts that underlying demand and the labor market are both strong, and inflation has been high and broadening.9 He added, “We’re going to have to see whether this Ukrainian situation changes that narrative.”
The stock and bond markets already seem to be pricing in expectations of a 50-basis-point rate hike at the next Federal Open Market Committee meeting in March. The evolving situation in Ukraine, and its impact on the global economy, may determine the extent of rate hikes that follow.
Pandemic-imposed restrictions may be ending
Across the United States, as the number of new COVID-19 cases continues to decline, more states are lifting mask mandates. New York City Mayor Eric Adams is calling on companies to bring a speedier return to the routine activities of pre-pandemic life. He is asking firms to end their work-from-home policies. A study from the security firm Kastle Systems found that only 28% of workers are swiping their security badges to enter offices in the New York metropolitan area.10 The Mayor believes that is inhibiting the city’s ability to experience a post-pandemic recovery. He met with 100 chief executive officers and encouraged them to bring people back to the workplace.
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