Time for a fresh appraisal of the economy.
The war in Ukraine and Western sanctions on Russia have roiled commodities markets and supply chains. Inflation, already bad, has gotten worse. Can the U.S. weather these storms and stay out of recession?
US Economy
Let’s start with the bad news: Inflation. It’s going to get worse and last longer, chiefly due to higher prices of energy, grains, metals and other commodities Russia specializes in. We see CPI inflation peaking at 8.5% in March…the highest reading since 1981. Then, declining only slowly later in the year, ending 2022 at a still painful 6.5%. All the inflation ingredients… easy money, deficit spending, high consumer demand and supply chain problems…have come together to produce the worst bout of inflation in 40 years.
The Federal Reserve is pivoting to inflation, finally, after months of insisting it was temporary. This month brings the first in a series of rate hikes, likely each a quarter of a percentage point…a step toward getting prices under control, but not enough to really quell inflation quickly. Tightening faster would help with inflation, but at some point, that risks choking off GDP growth.
Look for the Fed to proceed cautiously, preferring inflation over a recession. Other threats loom overseas. The war, of course…as always with war, the outcome is highly uncertain. The U.S. is bent on keeping it contained to Ukraine, but there’s no certainty it won’t escalate. Direct conflict between the U.S. and Russia, the stuff of Cold War nightmares for 45 years, would surely weigh on the economy. Even without that scenario, the present war figures to sap European GDP growth.
Then there’s COVID-19 in China. While the pandemic wanes in the U.S., it is intensifying in China, prompting Chinese officials to order strict lockdowns in some big cities. That “zero COVID” approach could hamper commercial activity in the world’s second-largest economy (one reason for oil prices’ sudden drop). Set against these threats are some underlying U.S. economic strengths: The reopening of the economy after COVID, which spells a big increase in demand for all sorts of services, which make up the bulk of U.S. GDP. People want to get back to normal life, which means healthy spending on dining, travel, etc. A sizable savings cushion. Americans have $2.3 trillion more in savings than they likely would have if the pandemic hadn’t curbed much of their spending or prompted Congress to dole out stimulus checks. That cash adds to buying power, even as prices of virtually everything keep rising. Plenty of it will get spent this year. Perhaps most important, strong job growth, which is badly needed now. Add it all up and you get about 3% growth for the year…if no new crisis like a widening of the Ukraine war intervenes. After the past two years, that’s a big if.
Global Economy
Russia’s invasion of Ukraine is straining the global air freight industry. Up until recently, demand for goods shipped by air was robust, while the sluggish recovery in commercial air travel kept jet fuel prices low. Now… Jet fuel costs have leaped along with crude oil and other petroleum products. Average prices spiked from about $2.30 per gallon before the invasion to $4.00. Plus, the conflict has complicated some key air freight routes, as Russia and its adversaries close their respective airspaces to each other’s planes. Now, the skies over Europe and much of North America are closed to Russian flights, while most European and American planes can no longer fly over Russia, forcing carriers to seek alternative routes. Some routes, such as Helsinki to Tokyo, simply can’t be flown now. Per one estimate, 20%-25% of the air freight capacity between Europe and Asia has been taken off the market, further raising costs. That spells higher prices for everything from smartphones to video games, and any other product shipped by air...yet another source of inflationary pressure.
Central banks appear likely to move forward with monetary tightening. But they may take a less aggressive approach in response to the conflict in Ukraine. The dilemma officials face: How to manage rapidly rising inflation without derailing the post-pandemic economic recovery. This task is more difficult now that geopolitical unrest has resulted in a huge run-up in global commodity prices, particularly energy prices, which may put large swaths of economic activity at risk. Inflation is now the main concern of central banks in advanced economies, including the U.S., but officials can’t avoid risks stemming from the Ukraine situation.