Fleeting Peace Dividend Threatens Global Growth

Russia’s invasion of Ukraine threatens to derail the economic recovery well underway around the world. The first-order effects have driven up oil prices by more than 30%, and wheat contracts over 50% to an all-time high. The knock-on effects will all but guarantee slower economic growth and could lead to regional unrest if prices remain elevated. European markets have suffered the brunt of the drawdowns, with many off over 20% since the incursion. US and Asian markets, which in theory should be less exposed, are off in the 10% range. Market returns to date suggest that the conflict will be contained, and the economic effects will be limited to higher commodity prices. We see the risk of a further market downturn should the conflict intensify. Expect higher volatility in the coming weeks and months.

The latest US economic numbers all point to a robust recovery. The past two employment numbers were well above the estimated gains. February saw 678,000 jobs added, bringing the unemployment rate down to 3.8%. Over 200,000 workers came back into the labor market, bringing the participation rate up for the fifth month in a row. Wage gains eased in this month’s report, which eased concerns of a wage-price spiral that drove the 1970s inflation. Business activity continues to be robust, with a few early signs that supply chain issues are beginning to ease. The latest ISM Manufacturing survey was strong across the board, while the Services survey showed some strain due to labor and wage issues.

The increased uncertainty will likely give the Federal Reserve pause in their upcoming meeting. Markets are now pricing no interest rate increase in March. This is a radical change from the ½ percent move predicted as early as two weeks ago. Stagflation, a period of slow growth coupled with high inflation, is increasingly mentioned in the financial press. We believe it is too early to call off the recovery, but we could see a pause over the next few months. Growth will be lower than earlier forecasts due to higher oil prices, but we expect economic growth to remain positive. Additionally, slower growth and easier comparable periods are all but certain to lower inflation prints over the coming months. Equity markets will likely be range-bound, and fixed income yields will remain depressed until markets gain clarity.

Bottom Line: Russia’s invasion has upended the upward trajectory of the post-COVID economic recovery. Higher oil prices will depress growth by putting pressure on consumer spending and increasing the transportation costs of goods. Assuming the conflict doesn’t escalate beyond Ukraine’s borders, we expect markets to adjust to tighter oil and commodity markets. Expect volatility to increase as the world adjusts to this new reality. The Federal Reserve will likely act more deliberately, which should help support asset prices over the short term. The longer-term growth story remains intact. Increased manufacturing investment, strong consumer balance sheets, a robust labor market, and infrastructure investment will drive growth going forward.