Energy Crisis From Ukraine Invasion Might Weigh on US Inflation, Economy

By Andrew Moran
Andrew Moran
Andrew Moran
Andrew Moran covers business, economics, and finance. He has been a writer and reporter for more than a decade in Toronto, with bylines on Liberty Nation, Digital Journal, and Career Addict. He is also the author of "The War on Cash."
March 1, 2022 Updated: March 1, 2022

The Ukraine-Russia military conflict and the Federal Reserve could be the main factors impacting the U.S. economy in the coming months, market strategists say.

Russia’s invasion of its western neighbor has had many energy analysts and governments worldwide monitoring crude oil and natural gas prices. So far, the benchmark West Texas Intermediate (WTI) and Brent prices have flirted with $100 a barrel, while natural gas has held steady at $4.50 per million British thermal units (Btu).

Market analysts purport that prices have not soared as some experts had initially anticipated because U.S. and European governments have refrained from targeting Moscow’s energy sector with sanctions. But financial markets are on high alert.

Russia’s oil and gas exports account for 36 percent percent of federal revenues, while Moscow supplies Europe with 40 percent of its crude demand and the United States with nearly 10 percent of its oil needs.

Washington recently slapped U.S. dollar restrictions on the Central Bank of Russia and national wealth funds, but it exempted energy-related payments from these sanctions. The European Commission prevented firms from supplying Russia with the technology to update its refineries. However, critics of these actions, including Ukrainian Member of Parliament Oleksiy Goncharenco, argue that more needs to be done, such as embargoes on Russian oil and gas.

But U.S. officials have been adamant about not targeting gas flows to prevent additional spikes in prices. At the same time, some foreign policy experts believe that President Vladimir Putin might consider withholding oil and gas exports if the international community’s financial penalties become too severe.

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Russian President Vladimir Putin attends a meeting with his Azerbaijani counterpart at the Kremlin in Moscow on Feb. 22, 2022. (Mikhail Klimentyev/Sputnik/AFP via Getty Images)

In addition to energy concerns, Russia supplies the world with plenty of other critical products to the global supply chain, including aluminum, palladium, urea, and wheat.

Should the Ukraine-Russia crisis intensify and oil prices climb to their worst-case scenario of $150 per barrel, as JPMorgan Chase recently forecast (pdf), the U.S. economy could stall.

“If oil prices do continue to go up it absolutely is going to increase recorded inflation. But it also constrains spending,” said Richmond Federal Reserve President Tom Barkin during a recent symposium. “A lot of people, especially lower income folks, a huge amount of their income goes towards gasoline. So if those prices go up it dampens consumer spending and dampens the economy.”

An extended span of higher energy prices could drive higher price inflation and manufacture negative political and social impacts, says Louise Dickson, a senior oil market analyst at Rystad Energy.

“The sustained period of high energy prices has been further driving inflation, and price spikes this year have already caused geopolitical tension in Kazakhstan, so it should be expected that a sustained period of elevated energy prices will not only carry negative macro impacts but social and political, as well,” she said in a note.

Dickson added that it is unlikely Iraq, Saudi Arabia, and the United Arab Emirates (UAE) will lead efforts to champion greater production to balance energy markets.

Oil is expected to stay well above $100 per barrel, and this could spike “either due to being withheld by Russia as a weapon or swiped off the market due to sanctions,” she noted.

Diane Swonk, the chief economist at Grant Thornton, projects that the U.S. economy could handle six months of oil prices hovering around $100. But if prices were to climb higher for a sustained period, it could begin weighing on the nation’s growth prospects.

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Mike Wilson, Morgan Stanley’s chief U.S. equity strategist, warned in a recent note that sky-high energy prices could initiate a “polar vortex for the economy and earnings,” which would “perhaps tip several economies into an outright recession.”

Wells Fargo chief economist Jay Bryson disagrees, stating that today’s trends may “slow growth,” but “it’s probably not enough to push the economy into recession.”

Others suggest that current economic conditions, particularly on the commodities front, are unlikely to change amid war in Eastern Europe.

“The risk-off market environment, where bond yields are lower and investors mull the prospect of recession, is challenging to chunks of our (overweight) positioning,” wrote JPMorgan economist Mislav Matejka in a note, adding that signals do not show commodity flows abating.

“If one is selling on the back of the latest geopolitical developments now, the risk is of getting whipsawed.”

What About the Federal Reserve?

The latest debate unfolding on Wall Street is if the invasion of Ukraine complicates the U.S. central bank’s strategies to combat 40-year high inflation.

Speaking at the Economic Forecast Project, Fed Governor Christopher Waller explained that it is “too early to judge how this conflict will affect the U.S., or the world economy, and what the implications will be for the U.S. economy.” But he still expects the U.S. economy will expand at a solid pace, although it could be slower compared to 2021.

Because he believes inflation will remain elevated this year and only spotlight “modest signs of deceleration” in the coming months, Waller advocates an increase to the target benchmark range by 100 basis points by the middle of 2022.

“I believe appropriate interest rate policy brings the target range up to 1 to 1.25 percent early in the summer,” he said.

San Francisco Fed President Mary Daly says inflation is high, endorsing a quicker pace of rate hikes. But she does not think a “long and painful correction” for the world’s largest economy will transpire this year.

The Ukraine-Russia war is unlikely to dissuade the central bank from normalizing monetary policy, telling the Los Angeles World Affairs Council, “I don’t see anything right now that would disrupt our plans to move the rate up off zero. Inflation is too high.”

Chicago Fed President Charles Evans does not propose mirroring the “extra monetary restraint” of the inflation-fighting Paul Volcker and Alan Greenspan eras that led to economic speed bumps.

Still, Evans told the Monetary Policy Forum, organized by the Chicago Booth Initiative on Global Markets, that the Fed would eventually get to a “neutral” policy rate of 2.5 percent that will neither boost growth or restrain demand.

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St. Louis Federal Reserve Bank President James Bullard speaks at a public lecture in Singapore on Oct. 8, 2018. (Edgar Su/Reuters)

Federal Reserve Bank of St. Louis President James Bullard supports raising rates by 1 percentage point by July, telling SiriusXM Business radio that he does not see too much of spillover effect from the Ukraine-Russia crisis on the U.S. economic outlook.

“The direct linkages to the U.S. economy are minimal, so I wouldn’t expect that much impact directly on the U.S. economy,” Bullard stated.

He further asserted that his colleagues have not “moved fast enough given the inflation developments.” Should the key policy rate climb by one point, “then we could assess at the point where we are at and what the next steps would be.”

Early first-quarter GDP forecasts show slower growth compared to the fourth quarter.

The Fed Bank of Philadelphia’s median Q1 Nowcast stands at 1.9 percent. The lowest projection is the Atlanta Fed Bank’s 1.3 percent, while the most bullish expectation is TradingEconomics.com’s more than 3 percent prediction.

With BMO Capital Markets estimating that every $10 increase in the price of oil adding 0.4 percentage point to the inflation rate, the Fed might need to heed Bullard’s advice and be ultra-aggressive at the next two-day Federal Open Market Committee (FOMC) policy meeting.

According to the CME FedWatch Tool, the Fed is poised to take a more cautious approach and pull the trigger on a 25-basis-point rate hike.

The rate-setting committee is scheduled to meet on March 15–16.

Andrew Moran
Andrew Moran covers business, economics, and finance. He has been a writer and reporter for more than a decade in Toronto, with bylines on Liberty Nation, Digital Journal, and Career Addict. He is also the author of "The War on Cash."