Moody's Talks - Inside Economics - Bonus Episode: Update on Russian Invasion of Ukraine

Episode Date: March 2, 2022

Mark, Ryan, and Cris welcome a number of Moody's Analytics colleagues from around the world to discuss the latest developments in the Russia-Ukraine war and what this means for the global economy.Full Episode Transcript here. Questions or Comments, please email us at [e-mail]. We would love to hear from you.  To stay informed and follow the insights of Moody's Analytics economists, visit Economic View. Hosted by Simplecast, an AdsWizz company. See pcm.adswizz.com for information about our collection and use of personal data for advertising.

Welcome to Inside Economics. I'm Mark Zandi, the chief economist of Moody's Analytics, and this is a special bonus podcast about Russia, Ukraine. A lot going on. It seems like things are moving minute by minute. And I thought it would be useful to give you the listener an update with regard to how we think things are playing out and what it means for the global economy. And to that end, I've asked, a number of my different colleagues to join us from different parts of the world to give you a sense of how we think the Russian invasion of Ukraine is playing out in these different parts of the world. So I won't introduce my colleagues yet. We'll kind of introduce them along the way, but let me begin with Garav Ganguly. Garav is leading the way in Europe, head of Amir economics, European Middle East African economics, and has been paying very close attention to this. Rob, can you just give us a sense of, you know, what's going on now and how you're thinking about how this is going to play out for the European economy?

Hi, hi, Mark, and thanks. It continues to be a very dark time for Europe. The war that Russia has launched against Ukraine is entering what appears to be a very brutal phase right now, given that it has made less gains than it probably had hoped to make in the first week. There reports of civilian casualties and economic destruction. We could actually be entering a phase where we see very high civilian casualties. There's clearly a humanitarian disaster in progress.

Reports of half a million refugees are more pouring into Poland and other East European countries. So it is a very dark moment in European history, I think. We have reports of the eastern city of Kharkiv under rocket attack, reports of cluster bombs being used, and Russian troops have actually taken over parts of the northeast and south of the country. The West has responded by imposing sanctions, UK, U.S. EU, various other countries have imposed wide-ranging sanctions, and these are too lengthy to list, but it's worth just highlighting some of these, given that these are having a significant impact

on the Russian system. The EU has excluded several Russian banks from the swift payment system. The US has imposed significant sanctions on two of the largest Russian banks, Burbank and VTB, and remove the ability to transact in US dollars. UK, US, and the EU have frozen the assets of the Russian central bank. that's quite significant because of the 630-odd billion of foreign reserves that the Russian Central Bank has. About 50% is in the currencies of these three regions. Russian aircraft can't use EU airspace and various individuals. A number of individuals and oligarchs have been sanctioned, raising concerns around property markets in particular parts of Europe, such as London and Switzerland.

Asset prices have also moved quite a lot, as you can imagine, over the last couple of weeks. a focus on oil and gas, which are primary drivers of inflation in Europe, certainly, and I talk a little bit about what we're seeing, early signs that we are seeing in Europe. Brent is trading at above $110 a battle right now. It's actually up about 12% since the 24th of Feb, when Russian forces launched their attack on Ukraine. European gas prices have spiked much more. So they're actually up about 80% since 24th of Feb, and are currently trading around 170 euros per megawatt. hour. That's very high back in December of last year when there was a temporary stoppage in one

of the gas pipelines from Russia to Europe, gas prices spiked at close to 200 euros. So this, the current prices is really another very high spike and it's quite alarming to see. Equity markets in Europe are doing not, not doing too badly. The footsees down a bit, Eurostocks down a bit. The reports that Euro stocks will actually remove stocks will actually remove various Russian companies from the from the, from the. index. And actually Russian companies, particularly Russian banks in Europe, listed in Europe, have seen the equity pretty much go to zero. In fact, Spurbank, Europe has ceased trading and will be liquidated. So quite a lot of impact from the sanctions and also, I guess,

uncertainty around oil and gas supplies, which is affecting oil and gas markets, and has the potential certainly to impact quite heavily on European inflation. Europe inflation came out, February inflation came out of 5.8%. year on year. That's not reflecting the current situation, of course, that's just reflecting the uncertainty that has led to a ramp up in gas prices over the course of pretty much all of last year. That 5.8% increase in headline inflation in headline prices also has underlying it a 31% increase in energy prices on a year on year basis. It's a very significant increase in energy price inflation. So there is now, I guess, a heightened sense of concern.

around the possibility for European inflation to continue to rise. So I'll stop there because there's a lot to talk about around this, but this is a very high level of what's been happening over the last seven days, a lot of uncertainty around the conflict and the war. White sanctions and response moves in oil and gas markets and concerns in Europe, particularly around inflation, potentially around supply. I should probably add that as of now, Russia continues to send gas into Europe.

Great. Yeah, nice. Thank you for that and obviously very disconcerting. Let me focus a bit on energy oil because that is the most obvious principle link between what's going on in Russia, Ukraine, and the rest of the world. And oil prices are up. And I'd go back a little further back in time before the Russia, Russia and actually invaded, because energy markets started discounting an invasion long before that. So my sense is that, you know, prices now, see you said Brent's like 110, a little over 110. WTI, West Texas Intermediate is about the same. A little bit lower than that. There's a bit of a spread. That's up about, I think, at this point, probably more like 30 bucks a barrel from where we were before Russia, Ukraine really got on the radar screen here. So, you know, I think that's, kind of the delta increase in oil and gas prices.

My, my, you know, in our outlook, you know, our baseline outlook, our most likely scenario. And obviously there's a lot of scenarios here, some of which are pretty dark, a lot of downside risk. But in the baseline, we're assuming that Russia, the invasion stops in Ukraine, that Russia doesn't go beyond that and that there is no disruption, significant disruption to Russian oil, natural gas, or other commodity supplies to the market. If that's the case, then our expectation is that oil is peaking now, roughly speaking, maybe not on a day-to-day or intraday basis. It can obviously go higher, given the uncertainties here, but that this is roughly the peak in price, and that by summer

and certainly by the second half of this year, because of these higher prices, we'll see some softer demand for oil in natural gas and other energy and some increase in supply because frackers here in North America can make a lot of money at this price. And I would expect OPEC, Saudi in particular, to pump a little tomorrow. We might see Iran come on with some oil that we'd see prices start to come in. That's kind of sort of how we're thinking about things in the baseline view. Does that make sense to you, Garab? Does that sound roughly right?

Well, first of all, did I characterize the outlook in your view in the way that you think about it? And does that feel like a pretty good baseline scenario? I think it's fair to say that in our baseline, we don't envisage any lengthy disruption in oil and gas supplies. Markets are going to be unsettled for some time to come over the next. few weeks, maybe even a couple of months, that's very likely. But we expect Russia to continue to supply oil and gas to Europe and to the rest of the world. And certainly from what we've seen

from sanctions thus far, sanctions have been very carefully crafted to exclude energy. That said, there's some tension right now. So we probably heard that various European energy companies are sort of shunning Russian oil and sort of self-functioning themselves, if you like. And that's That's an interesting development, and we'll see how long that takes to normalize, but certainly it's an interesting development that Europe is choosing on its own accords to actually walk back a little bit from Russian oil. We'll have to see what that does to markets. But I think it's fair to say that in the baseline, we would not envisage any significant

disruption in Russian oil and gas supplies, and that OPEC and U.S. would start to compensate, and this would lead to oil prices coming back in. And why are they self-sanctioning? I mean, this is surprised to me. I, you know, and this came, I guess, over the last 24 hours, this is starting to happen. But what's going on? Why are Western oil energy companies shunning Russian oil? What's behind that?

So there are probably a few reasons to this. One could be that it's actually quite uncertain as to how they might make payments for their oil. I've understood that shipping vessels, particularly so this is oil going in containers rather than pipeline oil into Europe, that containers, container companies and the owners of vessels are reluctant to transact with Russian companies to transport oil because they're not quite sure of the incidence of sanctions, whether it affects them. So they're holding back. And some of it, of course, they're reputational reasons around it in Europe for not actually

wanting to touch Russian oil at this stage. So probably a combination of factors, some of these issues might resolve over time, clarity over how the payment system might work, clarity around sanctions, et cetera. for these might just resolve over time. Right. Okay. Let me bring in a few of our other colleagues to weigh in on this. Chris, Chris DeReeds is the Deputy Chief of Commerce, Ryan, Ryan Sweets, the Director

of Real Time Economics, and also Jesse Rogers. Jesse is manages a lot of our emerging market analysis, and obviously emerging markets are critically dependent on energy and other commodities. Hey, Chris, Ryan, Jesse, anything to add. add on, particularly on the oil energy front that, you know, think is important. I mean, you know, obviously Putin could decide to cut off oil and energy supplies to the rest of the world. I mean, we're assuming he won't do that because that's cutting his nose despite his face. I mean, his economy is, the Russian economy is reeling and that would just completely

send it down the rabbit hole. So we're assuming that he won't do that, but that's possible. and we're assuming that these efforts at self-sanctioning kind of iron themselves out. But do you think there's a reasonable assumptions, is anything to add on the energy front? Chris, do you have any views on this? I know you're a little bit more bearish on oil prices, right, than what I just expressed in our baseline. Sure, I put a little bit more weight on the downside risks here, right? You described some rationality to Putin's decisions here regarding restricting oil flows, but that we're dealing with a non-rational or seemingly non-rational actor here.

So it's certainly plausible. I also question how quickly supply response can actually come online. Certainly there's a lot of incentive here for producers to pump or to explore, but we still have supply chain shocks that we're still recovering from from the pandemic. Those could certainly weigh on the ability to ramp up very quickly. So I think the supply will come, but I wonder how quickly it can actually get to market. Yeah, so we're, as I said, we're assuming that 110 is kind of sort of the peak, and we hang at these high levels for at least the next few months, probably through mid-year.

and then prices come in quickly in the second half of the year. You think that's a pretty good baseline view or you take much umbrage with that? As a baseline. That's a baseline, but there's a lot of downside risk. Yeah, that makes sense. Okay. All right. Ryan, Jesse, anything else on the energy oil markets you want to weigh in on?

Anything we missed? I mean, OPEC met today. And they announced that they're going to increase daily output, but they've been having a hard time meeting the past targets, but, you know, there is the supply response coming. Yeah, and I correct me if I'm wrong, but the Saudis, and I think the UAE, the United Arab Emirates, they actually do have excess capacity to produce if they had to. I mean, if other OPEC producers couldn't step up, can't meet the increase in their quota because they just don't have the capacity or the ability to do it, that Saudi could,

do that. Is that right? Yeah, that's correct. Okay. And if you're looking at the U.S., active rotary rig counts are still really low. And I understand Chris's point about supply chain issues, but, you know, that hopefully we can iron that out and we should see a big response, which we have at least in the last 10, 15 years when oil prices jump, you can start to see a lot of investment in mining shafts and wells in the U.S. Yeah, I have noticed in the weekly rotary rig data for the U.S., it has taken off. It feels like it's gone to a whole other level of increase here. So it's rising pretty quickly.

Which would you expect, given the high price. And it feels like it's moving in the right direction. Yeah. Okay. All right. Jesse, anything on the energy front you want to bring in? One thing I just add on the energy front with respect to EMs is there is sort of a huge, you know, differential impact for inflation or you are kind of talking about

the impact on inflation for Europe. and, you know, for EMs, energy is just a much larger weight in the consumer basket. So inflation risks are a lot higher. And I think that's really important to keep in mind as we kind of go forward and think about possible impacts going forward. So let's turn us right back to Europe to get a better sense of what's going on there. I was just on a call with a number of EU officials. And they pointed out a couple of other vulnerabilities that I'm, Garab, I'm curious as to what you think.

One was around refugees, Ukrainian refugees. They're anticipating a lot of refugees coming from Ukraine into the rest of Europe. And of course, where these refugees go is going to be quite varied across Europe, but this is going to be a significant issue. And I'm wondering, you know, what you think about that. And they also kind of downplayed the kind of the financial links between European banks and financial institutions and Russian banks and financial institutions. You know, I was looking at some data from the Bank of International Settlements. And just for context, it showed that at the end of last year, I think it was the third quarter

of last year, the last data point, U.S. banks had approximately $15 billion of claims on Russian banks, whereas European banks, and this is EU plus the UK, have something closer to $90 billion in claims on Russian banks, all of which I guess are at risk at this point. But is that a big deal or, you know, something to be worried about? And what are some of the other – I threw those two things out, refugees and the banking links. Are there any other kind of linkages between Europe and Russia that we think might be important to just consider here and put on on the table as potential vulnerabilities? So the refugee problem is definitely one that Europe needs to consider.

There are reports of millions of people having been displaced currently in Ukraine as a result of the war. And I think I mentioned right at the outset reports of about half a million pouring across the border into Eastern Europe. Europe needs to resettle refugees. And it's not just the EU. we're talking about here, even in the UK, rules around Ukrainian refugees and the right to enter, their ability to enter the UK have been relaxed. So it's clear that European countries are going

to accept refugees. They will be settled across different parts of the EU over time, I would imagine. And I would also imagine that at least for now, refugees will be holding on to the hope that they're able to get back to the Ukraine someday and that their stay in the EU is temporary. But of course, we have to wait and see as in when the fog of war recedes and what the lay of the land is as to what will happen there. It's also interesting in the context of the politics of Europe and the politics of the UK, which has all sort of been less welcoming towards refugees in recent years. But this war has changed that view. I think it's very clear support for Ukrainians and very clear desire to take Ukrainian refugees in

and give them, you know, the food and shelter the need, at least for a period of time. So that's the situation on refugees, as I can see it right now. On banking links, this has been studied in some depth. There's quite a lot of speculation about this for months, I suppose, but we mustn't forget that Russia, Russian organizations, Russian banks have been subject to sanctions or sanctions regime since 2014, and Europe has withdrawn to a large extent from the Russian financials, engagement with the Russian financial system.

So it is much less of a deal than it used to be. There are some European banks that are more exposed than others in Hungary, for instance, in Austria and even institutions, one or two institutions in France. But for none of these, is it an immense deal? And it's certainly not systemic from a Eurozone perspective. So we expect issues to arise in particular parts of the banking system. We've heard reports of banks, certain banks are spending dividends, etc. Because they're concerned about the Russian exposures.

But we don't see this as being systemic for the Eurozone financial system at all. Russian corporates, Russian banks, their listings in European markets. I mean, those days are over. We don't expect to see debt equity offerings in Europe for a long time to come. It's very unlikely that sanctions regime will be lifted anytime soon. I would be bearish on that. And also in the current context, over the last few days, Russian entities listed in Europe have simply seen values of debt and equity wiped out,

which of course is harmful for certain investors. I think the third, you also asked if there are any other links. So one of the interesting sort of side links that comes out, things like localized property markets, impacts. London, for instance, has a fair bit of property in the hands of Russian investors and these Russian investors, no doubt, are looking to accept these properties as we speak. Switzerland is another area where we have a fair bit of property investments by Russians. So the ability of Russians to continue to hold on to these properties or perhaps transact hastily

and fire sales, some of their properties that's likely. At least in the UK, that's probably fairly limited impact on property markets outside of that specific region of central London. In the longer term, we would expect that flows simply change, scope the way in which Russians have invested in Europe. That's just going to change. Those days are simply over, so we should expect to see,

not expect to see a resumption of that. Great. Okay, well, that's helpful. So just to kind of put a number on our forecast for Europe, and here I'm EU, mostly thinking about the EU, the European Union, in our baseline, under our baseline,

assumptions about how all this plays out is that European real GDP growth this year in calendar year 2022 will be about, you know, a half point, maybe a little bit more than half a point below what it was prior to all of this mess. Does that feel about right to you at this point, Grav? Are you feeling good about that expectation or are you, are your things getting darker for you? We've been thinking about this for a while, and I think we still hold that view. Our February baseline forecast for 2022, for the Eurozone is about 4% growth. So growth is suffering this quarter next, and after that, that's inevitable, I think. Half a percentage point feels bad right.

There's a fair bit of uncertainty around this, so I wouldn't be surprised to see it get slightly better or even get slightly worse. But as things stand right now, Bolt Park, a half a percentage point reduction in 2022 growth, feels like the right sort of direction of travel for the baseline. Okay. And before we move on to the rest of the world, let's just quickly talk about Russia and Ukraine. Obviously, for the Ukrainian economy, this is just, you know, complete catastrophe. I can't even imagine what this means, you know, for that economy. For the Russian economy, it feels like they're just gone into the abyss here.

And it doesn't feel like there's any way out. I mean, as long as Russia is in Ukraine in a significant way, meaning occupying Keeve or Kharkiv or, you know, big parts of Ukraine, it doesn't seem as if the U.S. or Europe or other Western or other economies are going to change their sanctions. The sanctions are going to remain very tight, you know, it may even get tighter here as we go forward. It feels like every time I look at a website, you know, I'm seeing another company saying that they've stopped shipping shoes or shipping iPhones or, you know, people are just cutting off their links with Russia.

And I don't think there's any going back here until the Russians figure out a way to leave Ukraine. So that feels like there's nothing but negative numbers for a big negative numbers for the Russian economy for the foreseeable future. Does that sound right to you? Or does that make sense to you? I guess so. I think the issue here is one of uncertainty. It's really hard to see how bad it's going to be in the near term. And in fact, it's easy to make it very, very bad and then make it worse the next day.

So we've also got to hold back from that. Ukraine clearly huge amount of devastation going on. And as I was pointing out earlier, we seem to be entering a new more brutal phase of this attack with Russia launching all out bombardment of cities. So damaging killing people and also damaging infrastructure, ruining economic structures, destroying cities, etc. That's a huge loss to output. I mean, currently I would imagine that industrial production is just all geared towards supporting

the military effort and any other kind of production, other kind of service, which is ground to a hold. So in the immediate term, things have clearly fallen off a cliff. But even looking ahead, it feels like with the kind of devastation that the country is likely to sustain, the road back is difficult. Now, if peace returns in a positive way and Russian forces pull back or there's a Ukrainian victory, I could really see a very big international reconstruction effort kicking in, which would be very positive for the country. So there's hope there. In darker scenario, where that doesn't happen, then this could be a very nasty, long-drawn outcome for Ukraine and its people.

Russia, I think you're right. It's become an international, pariah state. The actions of the last week have really been very egregious. There's no way out for Russia right now, unless, as you said, completely withdraws from Ukraine, but even then, given what has happened over the last seven days, there will be outstanding issues around war crimes against humanity, reparations. to be paid, et cetera, et cetera, which make it really hard to see the way forward for Russia. It feels like they've become an international pariah state.

They will stay that way for a long time to come. Russia is just completely isolated from the world economy. And a lot of countries that will not want to do business with it. Some, however, might. And as long as it has a fair amount of power in global commodity markets for oil, gas, and various other commodities, there will be countries that will be willing to transact with Russia, even those that have imposed very strict sanctions against it. You don't forget that even back in the worst part of the Soviet Union,

Russia that sent its oil and gas into Europe. Yeah, okay, fair enough. Hey, let's move on. And before we talk about what it means for different parts of the global economy, let's talk about the rest of the commodity markets. I mean, because Russia and Ukraine, export oil, natural gas, but a lot of other metals, you know, everything from titanium to palladium, various gases like neon, agricultural products like wheat, I believe corn as well.

And Jesse, can you give us a sense of what's going on in some of these other commodity markets in terms of, you know, we're seeing what's happening very clearly in the oil market. We're seeing what's happening with natural gas, particularly to Europe. What about these other commodity markets? How are they performing? What's going on with prices? When you look at non-oil commodities, whether you're looking at industrial metals or agricultural prices, and the key differentiator is, you know, goods or commodities that Russia directly exports and that Russia is a really big player.

So aluminum prices and weak prices are at record high, surpassing heights, you know, during the commodities boom of the past decade. Whereas the increase in copper, you know, copper prices have increased. is sort of a bellwether for non-oil commodities as a whole. But there aren't quite as high as they were, you know, earlier this year. The long and short of it is even if we come off of, you know, these peaks, commodity, non-oil commodity prices are going to remain high. And that's going to be another headwind to global supply chain issues and inflation more broadly. I know, Ryan, you look at these markets too pretty carefully. Anything you want to point out in terms of pricing?

Or any disruption supplies, anything at all on the commodity side? No, I think Jesse covered it all. Okay, okay, very good. All right, so let's now talk about what it means for the U.S. economy. And, you know, Chris, my sense is that it should be small.

Again, in our baseline world where we're assuming Russia doesn't step outside of Ukraine, Ukraine and that there's no significant actual disruptions to energy or other commodity supplies. That, you know, eventually the risk premium in these markets will start to come down, we'll get more supply, and we'll start to see prices come in, and things will moderate. And the U.S. is very energy independent.

You know, higher oil prices are a negative, but a very small negative because, you know, obviously it hurts consumers, American consumers, particularly low-income consumers. but it benefits the energy industry, so the net of all that is, you know, a small, small negative. What do you think? Am I, are we being too polyanish about all this? I mean, I talked about the banking links. They're very small. The trading links are very small. You know, there's some concern that maybe if Europe weakens, there's going to be some blowback on the U.S. because of the trade with Europe, but that's all, when you do the arithmetic there, that doesn't add up to a whole lot. So what do you think?

Are we being overly optimistic here with regard to the impact on the U.S. economy? I think we might be. I think there are, again, there are significant downside risk, some of which we haven't, I think, uncovered yet. We're only a week into this war. I worry about consumer confidence or confidence in general, right? if this is a protracted long war that grinds on week after week, month after month, I think that could certainly affect consumer psyches and also the expectations as we think about inflation.

So I do worry that the Fed's going to have to take more aggressive actions, for example, around inflation that would certainly cut into growth. So I don't want to paint the – I don't want to adopt the darkest. scenario as the baseline quite yet, but I would certainly be more cautious at this point. The only upside I see is some regime change, right? Based on what we've just discussed here, I don't see how this ends otherwise in a positive light. So, I mean, I don't see that happening very quickly or very easily. Yeah, right, right.

Yeah, I guess in terms of the downside risk, you mentioned inflation expectations. I mean, obviously, they're already pretty fragile coming into this because of the pandemic effects and high inflation and felt like inflation expectations, certainly for consumers, was pretty high. And this may, what you're saying is because gas, particularly gasoline prices, because they pay such an outsized role and people think, thinking around inflation expectations, that this could cause, what central bankers would say, what the Fed would say, unanchoring of inflation expectations. And when that happens, you run the risk getting into this wage price spiral and the Fed and other central banks will not tolerate that. And they'll step on the brakes a lot harder than what we expect. And that raises the specter of a recession later this year going into 2023. That feels like a pretty significant risk. Yeah. I also worry about some of those other commodities that Jesse mentioned, the metals and whatnot. And I think oil actually, we have a little bit

more flexibility. There are other countries that can increase production and fill in the gap. For some of those other metals, I don't know that we have as much flexible. I think we are quite dependent on Russian exports. So that's just another supply chain related risk I see out there. Yeah, good point. I guess the other thing I would bring up is the stock market, right? Stock market is down a little over 10% now from its all-time high, said at the beginning of the year before all this mess began, which by itself is no big deal, right? I mean, because it was up 30% last year and, you know, 10% is like a garden variety

correction that I don't think I'd worry too much about. But you could construct, because it is pretty highly, market is pretty highly valued, and there was a lot of sign of frothiness building in. You could see, and it kind of was, you know, pricing in some nothing but good news going forward. And clearly, Russia, Ukraine is nothing but bad news that we could see prices fall a lot more, down 20, down 25, down 30.

Yeah. I guess that could be a problem. Yeah. Then definitely you're talking consumer spending effects, people pulling back and worried about their nest eggs. Yep. Yeah. Okay.

All right. Okay I was going to say one other thing about that But I can't remember what that Maybe Fed policy You want to turn to Ryan? Yeah, oh yeah, that was it Yeah, absolutely.

Right. So Ryan, because of our, again, I keep going back to the baseline It's kind of the, you know, the stake in the ground that we're kind of thinking about these things. There's this push in this pool I mean, in terms of monetary policy.

I mean, obviously the the push is that we've got higher inflation and potentially higher inflation expectations. The pool, or maybe it's the other way around, push or pull. You get one in my draft. Yeah. The other is it's going to hurt growth. So it's a classic supply shock that discomplicates things enormously for central banks and the Fed.

What does the Fed respond to, the weaker growth or increase uncertainty or the inflation? So I think we've landed on, well, the crosswinds kind of wash each other out, and we have no change of monetary policy. Is that right? That's correct. And if there's any risk, it's just the risk that the Fed does more because they have a zero tolerance policy when it comes to inflation. So if we get some upside surprises relative to their forecast on the inflation front, then they're going to put their foot harder on the on the break because unlike past instances, we've had oil supply shocks, you know, inflation was pretty low. Now it's already high. And if inflation is going to keep it higher for longer the Fed's not going to tolerate that and they're going to raise rates more than what

is Pennsylvania or baseline forecast so we have four rate hikes quarter point each this year march in a couple weeks June September December what's what are the markets now saying because at some point seven Russia are they still saying seven right they went back up to seven okay I checked this morning so they went down below six and then they went back up to seven because I think they're doing the same thing we are inflation expectations are going to increase because of higher oil prices, retail gasoline prices. And then also the CPI is going to remain elevated for the next few months.

And that to them is a hint that, you know, the Fed's going to go more aggressively. So prior to Russia's invasion, the markets, investors were kind of starting to price in a half a point increase. Yeah, that's the funds rate target. That's gone. Yeah. Yeah, I think I checked this yesterday. It was 100% before Russia invaded Ukraine. Now it's down to zero.

Zero. Okay, so what's going on? This is my way of framing it. Because of the uncertainty created by this event, the thinking is the Fed's not going to go a half a percentage point at the March meeting. They're going to go a quarter point. And so the markets now are all in on that. But because all of this means higher oil, commodity prices, higher inflation.

inflation expectations could come undone, the markets expect still the same seven rate increases, but I guess that would be, would that be one at each meeting? No, there's. It is. It's one at each meeting. For the rest of the year, yes. For the rest of the year, yes. FOMC meeting, okay, for the rest of the year.

Okay. And March is a done deal. So Fed Chair Jerome Powell testified today, his semi-annual report to Congress. And he said, we're going to raise interest rates later this month. So we know 25 basis points in coming. Okay. All right. And so we were four before Russia invaded. We are four now. Markets were at seven before Russia invaded. They're at seven now. So we had kind of a different perspective on how aggressive the Fed was going to be, but still do. Nothing really has changed here. Fed policy, monetary policy has unchanged as a result of the Russian invasion. You know, I think the market's doing some of the feds work for them. So that's why it's hard to see them doing seven interest rates.

I mean, financial market conditions have tightened a lot. You've seen corporate bond spreads widened out. They're still really low from a historical perspective, but they're winding. The stock market, as you said, is down 10%. So if it goes further, you know, that actually takes rate hikes off the table because the markets are doing, you know, some of the feds work. That's a great point. So the monetary policy affects the real economy. largely through, or at least primarily through, initially through financial conditions,

stock prices, credit spreads in the bond market, interest rates generally, you know, that kind of thing. And so because the Russian invasion has caused, stock prices to fall, caused corporate bond yields to rise, the borrowing costs for businesses to rise, that has taken some of the pressure off of the Fed. So it's almost like that is a rate hike, an additional rate hike by the Fed. Okay. All right. That makes a lot of signs. Okay.

Very good. Okay. Let me bring in one of our other colleagues at this point. Adam Kamens. Adam, welcome. Adam manages our U.S. regional economic analysis. And I asked him to join because I'd like to hear a little bit about what you think this means for different regional economies across the U.S.

How has your thinking changed with regard to that? Thanks, Mark. So as everyone's sort of suggested, as you suggested when you're talking to, Chris, the shock to the U.S. economy is going to be fairly mild, at least in the baseline. But there are some real differential impacts. So the way I think about it is there's sort of energy market impacts and then everything else. So in terms of energy markets, right, we already touched a little bit upon the fact that oil prices are going to be high across the U.S. across really all major shell plays in the U.S., prices are going to be above break-even for a while.

So I think we're going to continue to see more investment, more drilling taking place. So places like Texas, North Dakota, Alaska, Oklahoma, all these places that really depend on the energy economy, on oil, are positioned to benefit to some extent. Now, I would caution everyone not to get too optimistic about the prospects for those states, I think, right, there's enough uncertainty around kind of where oil prices are going to go that I don't know that they're going to invest as if, you know, we're going to have a hundred dollar barrel oil for the next six to 12 months per se. And then there's a lot of concerns around costs. Capital costs are high, labor costs are high. Because of all of that, I think that investment's going to be a little bit more restrained than you might otherwise see when oil prices are what they are right now. And then the other kind of positive impact, I would say, would just be some spillover to the Midwest. and portions of the country where oil drilling equipment is being made. So just sort of downstream and upstream impacts throughout the supply chain for energy producers. I think you do get a benefit there.

So that's kind of the upside. The downside is much more diffuse. So we can't identify sort of a handful of states the way we do with oil producers and say these are the states that are going to be hurt significantly more than others. but there are some ways to differentiate. So I think the most important one is looking at the consumer picture and where rising gasoline prices are going to hurt most. So kind of the first thing we look at whenever there's an oil price shock in either direction

is where do people drive the most, right? And where do they use the most gasoline? So actually, I can quiz everyone here. We don't quite, I know we don't have time for quite a numbers game here. Yeah, it's not appropriate. but my guess is low-income households in the southeast is where you'd see the biggest impact because that's where folks drive the most. Is that right?

Exactly. So I was going to ask which state. Yeah, exactly. So I was looking at which state. Georgia, North Carolina. You're in the ballpark. Yeah, it's Alabama, Alabama, Mississippi, the Dakotas. Those are the states where there's the most gasoline consumption per capita.

So right, that reflects the fact that people drive more. Also reflects the fact that EV and hybrid penetration is lower, people are driving larger vehicles, in those regions. So the impact of higher gasoline prices is just going to be more pronounced, and the impact on consumers is going to be more pronounced in those areas. And then firms that rely on energy as an input are also going to be hurt, right? So automakers are going to be hurt, not so much because they're relying on, they are relying on energy as an input, but just because the broader impact to gasoline prices. And then there are a handful of other energy-intensive industries, the paper production, cardboard production industry, actually.

is one that's been doing quite well with, you know, since the pandemic, with more packaging being produced. That one takes a major hit. That is among the most energy-intensive industries out there. So any area that depends on that will also face a little bit of a setback. I can stop there. That's kind of the energy picture. I don't know if you want me to dive into some of the other impacts as well or if we want to kind of pause down. Well, you know, Garab mentioned some localized impacts on real estate markets because of

Russian, particularly Russian investment in those markets. Do you have any examples of that here in the U.S.? Yes. So there's two markets that I think are most concerning. That would be New York City and Miami. Those are markets that probably not to the same extent as London or in Western Europe, but those are the two markets in the U.S. that do have a bit of exposure to Russian investment. So just to give some context, one specific Russian oligarch, right, Abramovich, I believe, his name has over, I think it's over a hundred million in properties in Midtown Manhattan. There's generally these oligarchs have not been sanctioned directly yet, but certainly the ultra luxury market in both of those cities demand is very limited.

There's only a handful of people that can afford these really high-end apartments. And Russian oligarchs are generally them and a number of wealthy Chinese investors. and so you're losing part of the demand pie there. The one thing I'll say about all of this is that a lot of these very wealthy Russian individuals who are buying properties in these markets, it's not as if sort of they're, you know, closing, signing their name and it's just kind of attributed to them directly. There's shadow corporations there, sort of other entities of play here that I don't think it's kind of a straight line to, you know, from sanctions to suddenly, you know, these Russian

Russian buyers are just totally out of the picture. Okay. Very good. In terms of trade between the U.S. and Russia, what are some of the major things that the U.S. ships to Russia, exports to Russia, and do they have any regional consequences? A little bit. So transportation equipment is the biggest one. So the two states that have the most exposure to Russia as a destination.

nation for exports are South Carolina and Washington. So South Carolina is motor vehicle parts and cars generally. Washington is all, it's about aerospace, right? Aerospace equipment going to Russia. Both of those are going to grind to, I think, maybe not grind to a complete halt, but pretty close with the sanctions regime and possibly some self-sanctioning as well. Is that a big deal in the grand scale? Yeah, it's not that big a deal.

though. So just to put it in context, so South Carolina is the state that over the last years has the highest exposure to Russia as an export market. It is the 20th highest, in terms of the countries that South Carolina sends its products to, Russia ranks 20th on the list. It's less than 1%. So it's not really going to have a material impact on the economy there. I guess as I mentioned earlier, one other question I get is, well, if the European economy struggles as a result of this, then what does it mean for the U.S. trade? So are the regions of the country that are more exposed to Europe? I mean, I would assume the Northeast, if my recollection is correct. Is that right? Yeah, that's right. Generally, the Northeast is the most exposed to the

European economy, partly through trade, and then partly just through the flow of people back and forth, or travel back and forth to Europe. I think, I don't think, you know, Russia, obviously Ukraine are not big markets in terms of attracting visitors to big northeastern cities. But if the rest of Europe is severely disrupted and suddenly the flow of tourists from London or Paris or Italy or wherever, is that, you know, Germany, if that slows materially, then that is a very significant impact on the northeast. But that's a risk.

I don't expect that to happen. Yeah. Yeah. Okay. Any other links that we're not thinking about or I'm not thinking about? I'm not thinking about in terms of the U.S. in Russia that has a regional, differential, regional impact? I'll give you a couple, just kind of quick hitters here.

So one would be farms and farmers, right? So we talked a lot about wheat prices already. There's a lot of volatility there. There could be upside associated with wheat prices. But Russia is a big exporter of fertilizer. So that is going to push farmers costs up. all of this means consumer prices for food are going to go up. But there's just, I think, even more uncertainty for farmers,

which unfortunately for them is kind of part for the course when there's big geopolitical events. We saw this with the trade war a few years ago. But I think just more risk in both directions for farmers. And the other one that I would highlight, and this actually is a follow-up to something that you talked about the podcast last week would be neon exports from Russia and the impact on semiconductors. Right. And so that could have a significant impact on the Western U.S. in particular, Silicon Valley, Portland, Phoenix, Boise. These are all places that have a very large semiconductor manufacturing presence. There's been a lot of talk, actually I think in the State of the Union this came up, the new Intel plant in Columbus, a lot of excitement around the possibility of domestic semiconductor manufacturing, rightfully so. But this could be very disruptive to that. And some of the upside there might take a hit. Great. Well, thanks, Adam. That was a really good swing around the country. So let me now turn to another colleague, Alfredo, Alfredo Coutino. Alfredo manages our Latem team. And Alfredo, I haven't really thought about Latam that carefully, but it feels like there's a lot of crosswinds here. That, you know, higher commodity prices is probably a good thing for a lot of the Lyon M economies. But yet, you know, Ladd M is, you know, tied in to. to China and the rest of the emerging world.

And in terms of growth, it can't be a good thing. But what is the net of all that? Is this good or bad for them? So far, it's good. And actually, I would say that unlike other external shocks in the past, we could see that there are some benefits for Latin America so far. I'm talking about in the past two months. particularly in the last week, basically because, first of all, the region doesn't have

strong financial links with Russia, with Ukraine, a little more with Europe, particularly with Spain, with Spain, UK, Germany, but financial markets have not been impacted significantly in the past a few days. And actually, what we see is that it was only a small overshooting in currencies. That was last Thursday when things were more uncertain between Ukraine and the rest of the world. but then Latin American currencies appreciated. So in net, I would say that in the past two weeks, Latin American currencies have not depreciated, but on the contrary, they have revaluated.

Now, one important factor behind this is the high commodity prices, as you mentioned, is a positive for Latin America. So governments are getting extra export revenues. Central banks are accumulating more foreign reserves. And that explains to a great extent why Latin American currencies are behaving positively. But of course, it's just a week since the military conflict started. So it's too early to say, so what is going to be the impact on the military conflict started. So it's too early to say, so what is going to be the impact on the real economy?

But so far, I mean, exports in Latin America have been performing very well, not only this year, but since the second half of last year. And I would say, like a common denominator for most of the countries in Latin America, if there is a negative impact in coming months, it's going to be minimum. the government is getting extra revenues to upset or counter any potential inflation impact on consumer prices. So that's what we are seeing now in Latin America. Okay, great. And so I guess the economic jargon would be the terms of trade have shifted in favor of LATM economies just because prices are up for the things that they produce. produce for the commodities. Yeah, right.

Yeah, yeah, absolutely. And so far the growth effects are minimal, doesn't feel like that's going to be a big deal. So the price effects are a plus here. Yeah, and actually there is a side effect which could also benefit Latin American exports. And that happens two years ago when it was an aggravation of the trade frictions between the US and China. So the US turned to Latin America and producers of a. agricultural products and it started to import from Latin America.

So something similar could happen here also, particularly because Russia is a big producer of agricultural products. So Latin America could gain some market share in this particular. Yeah, I guess in a sort of kind of a way of thinking about it is Russia is kind of sort of like an emerging economy, really, when you think about it. And so what happened is Russia is no longer really a player. in these markets or much less of one. Or there's the fear that they will be, and therefore that's driven up the price.

So it's benefiting other producers of these commodities, and that's Latin economies. Absolutely, yes. Yeah. Yeah. Okay. Okay. Okay. Very good.

Well, thanks for that. And then finally, I want to, we're kind of going around the world here. Finally, I want to land with Steve Cochran. Steve manages our efforts in Asia. And Steve, kind of sort of like emerging markets here, it feels more like a small negative, not, you know, I don't think it's a positive because Asia consumes a lot of energy in these commodities, doesn't produce a lot of them. So the terms of trade have shifted away from Asia. But, you know, the impact here feels small. Is that a fair characterization?

I think that that is fair. I don't think we'll see the impact here that we see in Europe, but it's not the plus that Alfredo was talking about in Latin America. You know, that the channels by which the Ukraine war impact Asia are through energy, if I, there are four basic channels and ordered. The biggest one, of course, is energy because all of Asia, with the exception of Malaysia is a net energy. importer. And then food prices will be very, very important in terms of what happens with inflation. The third is supply chains, much like what Adam talked about with the U.S. semiconductor makers. And the fourth, but maybe less so is financial volatility. But with energy, this is a very important aspect of the economy because the economy has

been doing very well, and much like Latin America, the exports have been strong over the last year, and the fourth quarter was very strong in Asia, even into this January, February, industrial production has been very strong, and exports have continued to be strong. But that advantage may begin to disappear if demand from Europe in particular begins to have at the same time that costs of energy begin to rise. There's not a lot of direct deliveries of energy crude oil petroleum from Russia to Asia. It's all indirect, so it's really just the direct, indirect price effects. With two exceptions, China and India do buy a fair amount. of crude oil, petroleum, and coal directly from Russia.

So if those supplies are cut off in any way, that would actually be to the detriment of China and India. I mentioned food second because food inflation has been very critical in Asia, that where inflation has been high to a high degree, it is because food prices have been high. And energy plays into the cost of production and distribution of food. And this again, India seems to come up a lot. I think if there's one single country that is probably at the highest risk, it is India. And because, one, it has the highest inflation right now in all of the major Asian countries.

It's a 6%. And it actually went up last month to 6%. And much of that is because of food. and there is some exposure to imports from Ukraine in particular in India. There's been a shortage for a while of edible oils, cooking oil, in India, and a lot of that has been lately provided by Ukraine. They provide safflower oil, sunflower oil and such, and that may be gone, and they will need to look for other sources of that.

That could add to food inflation. it could then tick up total inflation. Right now, it's right at the very top of the Reserve Bank of India's inflation target rate, which is between 4 and 6%. And the RBI has been holding back on raising interest rates, trying to give the Indian economy a chance to get back on both feet. And they're going to have some tough decisions to make very soon about policy normalization. And I think policy,

and going to Ryan's point about the Federal Reserve, one of the risks in Asia is that our baseline forecast is that, except for a few countries where inflation now does exceed target rates, like in Korea, Singapore, and New Zealand, the central banks would give the economies another six months or so at least to really show that they're back on their feet after COVID last year before they begin to normalize rates. the risk is that, you know, if the Fed were to say, hike by 50 basis points, then central banks in Asia might have to move sooner. It sounds like that risk is easing a little bit. And that's a good thing. I guess finally, to go back to supply chains, Korea, Taiwan, very critical providers of semiconductors and Malaysia and Thailand components for those semiconductors, it seems like the semiconductor makers in the region do have at least a near-term supply for all these rare

gases and rare minerals that go into chips, but it felt this lasts a long time, these supply chain shortages could ramp up once again. Right now it feels like supply chains in Asia are really beginning to ease up. Things aren't nearly as bad as they were back in the, say, the third quarter or fourth quarter of last year. And so we're okay in the near term. But if these supply constraints continue for some time, then we're back to square one on the supply chain issue for tech. Thanks for that, Steve. Quickly, U.S.-China relationship, obviously quite tense. Any discussions in Asia around what all this means for that relationship or anything?

There are a lot of discussions. You see there are a lot of conversations going on, maybe is the best way to say, of just trying to figure out where Asia fits between China and the U.S. now. You know, for much of Asia, there's a very natural fit with China in terms of the very strong trade links and such. and also the fact that the U.S. had stepped away from Asia for some time. So the question really is, well, so is the U.S. really going to step back into Asia and Southeast Asia and take a firm role and actually encourage a more U.S. investment in the region and such and offset China? And then, of course, the conversation about China and Taiwan is always part of the conversation as well. What are the security risks? How heightened are the geopolitical risks in the region?

There's a little bit of uncertainty. There's also some, you know, positive feeling that, you know, as geopolitical risk becomes increasingly an important aspect of the whole risk appetite of, firms and so forth, that this could accelerate investment away from where investment is now concentrated, to a certain extent, China, of course, Vietnam as well, and spread out across, particularly Southeast Asia or India. So the risks, the conversations go on both directions, but certainly there's lots and lots of talk going on. Okay, very good. Okay, we covered a lot of ground. Guys, anything I missed that I should have brought up in the conversation? Any other points?

No? Okay. All right. Well, very good. This is obviously, this is the second podcast we've done, I think, in the last two weeks on Russia or Ukraine. And there'll be more. We have a webinar next week where we'll kind of reprise this conversation, but we'll, you know, have some more graphics and more in-depth discussion. And, you know, we will continue to bring you, uh, any chance.

changes that we make to our thinking about the economic outlook. So with that, let me call it a podcast. And thanks very much for attending. Take care.