The prospects for economic growth domestically are dimming as the world deals with the devastation and fallout from Russia’s invasion of Ukraine. This severe human tragedy is leaving the country in rubble and raising the risk of a third World War.
While one hopes for a peaceful resolution through diplomatic measures, Mr. Putin appears set on redrawing boundaries from the former Soviet Union. Despite crippling sanctions and near consensus disapproval from NATO members, tensions continue to mount.
Before the Russian invasion on February 24th, forward looking economic measures for the US had fallen to the lowest level of the post-Covid recovery, according to ECRI (see leading index of economic activity, or WLI, below). With this week’s disappointing ISM Non-Manufacturing PMI and the Atlanta Fed’s own Q1 real GDP estimate falling to 0.0%, the long-awaited post-Covid bounce has failed to materialize in earnest and that window looks to have now closed.
The timing of increased geopolitical tensions could not occur at a more inopportune time. With inflation embedding in the economy, continued supply shocks will wreak havoc on an already strained global supply chain. Ukraine ranks fourth in the world in the total value of natural resources and is first in Europe in arable land. Russia produced 10.5 million barrels of oil per day in 2021, is the world’s third largest oil producer and supplies Europe with a third of its natural gas.
Oil has risen from $78 to $119 since Jan 1, 2022. While not every recession has been preceded by a spike in energy prices, every price spike has preceded a recession in the US since 1970. This week, oil reached the mark—measured as a +50% price increase in oil from underlying trend level (chart via Pictet):
Thus, the world is now on recession watch as global leaders look to avert further escalation across Europe and Asia. The US fiscal impulse that sustained many Americans during Covid is fading and monetary policy is on a restrictive path. Just this week, Chairman of the Federal Reserve Jerome Powell affirmed his position of raising interest rates above “neutral,” which he estimates between 2%-2.5%. The current level of Fed Funds sits at 0.0%-0.25%, thus a minimum of seven quarter-point hikes would be needed. With traditional policy measures, the Fed’s actions are counter cyclical (moving in the opposite direction of the underlying economic trend). However, the current set up positions the Fed to fall victim to a classic policy error—tightening into an economic slowdown. With inflation measuring 7.5%, no easy choices remain.