Russian forces launched their long-feared attack on Ukraine, and the crisis keeps getting worse at every turn. According to Russia, its first day of the Ukraine invasion had achieved all its goals, with Russian forces managing to destroy 83 land-based Ukrainian targets. On the other hand, official sources have reported 203 attacks by Russia on its western neighbor on the first day. Ukraine appears overwhelmed, with the country’s defense minister urging citizens to fight back with Molotov cocktails.
On Thursday, the United States, Canada, and the UK slapped fresh sanctions on Russia, including excluding Russia’s largest financial institutions from global financial systems; Imposing an asset freeze against all major Russian banks, canceling all export permits with Russia and prohibiting all major Russian companies from raising financing within their territories, among other measures.
Predictably, crude oil and gas prices are surging as Russia strikes major cities in Ukraine, hitting levels not seen since 2014. Brent futures (CO1:COM) (NYSEARCA:BNO) have jumped +8% to trade above $105 per barrel, while WTI futures (CL1:COM) (NYSEARCA:USO) have rallied by a similar margin to trade just a shade below $100 per barrel. The markets have been bracing for this kind of outcome given that Russia is the world’s No. 3 exporter of oil and No. 2 exporter of natural gas. Russia produces 10% of the world’s oil and 40% of European natural gas. Thus far, the U.S. and its European allies have made it clear they have no intention of impeding flows of energy out of Russia via sanctions. On its part, Russia thus far has not made any direct indications they will restrict energy exports, though the rhetoric is heating up and gas flows from Russia to Europe remain ~50% below the 5yr average. Experts are warning that Russia remains in a prime position to continue weaponizing its oil and gas assets, which could lead to severe price spikes, as we explained here.
Indeed, the crisis could very well change the trajectory of the U.S. economy and force the Fed to change tack.
According to Richmond Federal Reserve President Tom Barking, U.S. consumer spending will likely be curtailed and pose a risk to U.S. economic growth if the Ukraine conflict leads to sustained high energy prices.
“If oil prices do continue to go up … It absolutely is going to increase recorded inflation. But it also constrains spending,” Barkin has said at an economic symposium.
From Bad to Worse
The latest economic data revealed that U.S. inflation surged to a four-decade high of 7.5%, prompting Federal Reserve Bank of St. Louis President James Bullard to advocate for a supersized rate hike. In a research note, Goldman Sachs’ Jan Hatzius has warned that rapid progress in the U.S. labor market and hawkish signals in minutes from the Federal Open Market Committee suggest faster normalization, with the central bank now likely to raise interest rates four times this year and start its balance sheet runoff process in July, if not earlier.
But the Fed is suddenly finding itself in a bind. Whereas the world’s biggest central bank has been focused for months on curbing a surge in inflation sparked by supply chain snags and robust consumer demand, it had not factored in a fallout from a major war. Many analysts expected the Fed was to begin a new campaign of rate hikes in March; however, the Ukraine crisis may force the central bank to act even more aggressively as the conflict escalates.
The Ukraine crisis could also lay to waste forecasts by Fed Chair Jerome Powell and other policymakers that inflation might begin to cool naturally as Federal stimulus and congressional aid to the economy fade and supply chain bottlenecks ease.
Currently, higher energy costs present the biggest risk of further boosting U.S. inflation from its four-decade high, which is bad for the American economy, with consumer confidence hitting the skids. A University of Michigan survey showed that consumer confidence slipped 8.2% from January to February, with fewer consumers planning to purchase homes, automobiles, or go on vacation over the next six months amid concerns about the short-term economic outlook.
Indeed, there are fears that the U.S. economy could even slip into a recession.
Related: Metals Markets Brace For Chaos As Ukraine Crisis Worsens
Diane Swonk, chief economist at Grant Thornton, estimates that the U.S. economy can weather six months of oil prices averaging around $100, although it could worsen the inflation problem, but a sustained period of $125-a-barrel oil would almost certainly stall growth and lead to rising unemployment.
A few days ago, President Joe Biden warned Americans that a Russian invasion of Ukraine–and U.S. efforts to thwart–would come at a cost.
“My administration is using every tool at our disposal to protect American businesses and consumers from rising prices at the pump. Defending freedom will have costs for us as well, here at home. We need to be honest about that,” the President has said. Biden has revealed that the U.S. is “executing a plan in coordination with major oil-producing consumers and producers toward a collective investment to secure stability and global energy supplies,” adding, “this will blunt gas prices.“
At this juncture, it’s not clear what plan the president was alluding to, though it likely involves a coordinated sale of Strategic Petroleum Reserves (SPR) by several countries, including the U.S.’ 600 million barrels. That might be effective in the short-term but is likely to fall flat if Russia is willing to engage in a drawn-out battle of wills with other oil producers– especially now that it has a $630 billion war chest to its name.
By Alex Kimani for Oilprice.com
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