3. Inflation — We don’t know the extent to which global supply chains will be disrupted and some commodity shortages potentially exacerbated by the various sanctions (and by how Russia might respond to them). However, my sense is that they are unlikely to improve. Thus, I think we should assume a base case of higher inflation at least over the next few months.
January’s US Consumer Price Index (CPI) print was 7.5%,2 while the US Federal Reserve’s (Fed’s) preferred Personal Consumption Expenditures (PCE) Price Index registered 6.1% annually over the past year.3 While recent market consensus has been that inflation will likely head lower in the second half of 2022, our Global Macro Team estimates that the latest rises in oil and gas prices could add as much as 1.5 percentage points (ppts) to global inflation and subtract around .75 ppts from global growth.
4. Central banks — The heightened uncertainty will likely inject a healthy dose of caution into global central banks’ efforts to fight inflation in the months ahead. The 50-basis point (bp) rate hike that had been widely anticipated going into the Fed’s next meeting (in March) now appears unlikely, as does the expectation of further rate hikes coming out of every subsequent Fed meeting this year. The hawkish rhetoric we’ve been hearing from the European Central Bank (ECB) is also likely to be tamped down now.
The Fed, in particular, now faces a more complicated challenge than before: how to rein in inflation without tipping the US economy into recession. Striking that delicate balance may require the Fed to adopt a less hawkish policy stance, which could be a marginal positive for capital markets. On the other hand, the Fed has to make sure inflation expectations don’t become unanchored, which would force a more aggressive course of action.
5. Fiscal policy — To some degree, the conflict may be a catalyst for more fiscal stimulus in Europe, if not elsewhere as well. Higher oil and gas prices will be hitting Western consumers at an inopportune time for some of these fragile economies that are just beginning to heal from the pandemic-induced slowdown. In the US, the crisis may even give some renewed “oomph” to President Biden’s Build Back Better legislation.