War, Pandemic, and the Fed: Navigating Uncharted Waters

Photo by dimitrisvetsikas1969 from Pixabay Copyright-free

By

Victor Igono

Date Published

March 15, 2022

Category

Global

A month ago, global attention focused on the Beijing Winter Olympics. And inflation. The latter especially rankled as the world endured record-breaking inflation rates amidst high prices for energy, food, housing e.t.c. While Russian forces continued massing along Ukraine’s borders, the global consensus dismissed possible Russian incursion. A full-blown war was regarded as a near impossibility. Less than two weeks later, the first shots were fired. And the war has wrought significant consequences on the global economy, worsened the plight of humans, and scuttled gradual attempts at global economic recovery. Experts had expected an aggressive move by the US Federal Reserve and other central banks to rein in the scourge of inflation. Russia’s war and the recent spike in China’s covid-19 cases further complicate the policy choices before the Fed and bears consequences for other economies. 

The War

After the repeated denials, Russia invaded Ukraine. Whatever the motivation (ego, strategic preemption, or nostalgia), the consequences of the war have been far-reaching. Beyond the over 1.5 million refugees it has spurred, the conflict sent shockwaves through multiple markets. Oil prices shot up to $130, the first time in over a decade. Grain prices remain high, with a global food crisis increasingly possible. Other commodities, including nickel and natural gas, have been significantly impacted too. High energy prices as a result of difficulties in offloading Russian oil translates into higher living cost for consumers and businesses. This complicates the Fed’s planned rate hikes. Furthermore, freezes on Russian foreign reserves threaten its ability to meet debt obligations with the possibility of defaults in a few days. Considering the exposure of Western banks to these obligations (estimated at $120 billion), concerns remain on what, if any, impact such defaults could have on the global financial system. On the energy front, there are encouraging signs from OPEC members looking to fill the vacuum caused by the near-absence of Russian oil globally. However, other concerns remain. 

The Pandemic 

As the world got too focused on Russia, the covid-19 virus reared its head again. China reported massive spikes in covid cases over the past few days, prompting draconian lockdowns of some cities. China’s tough zero-covid strategy combined with the virus’ high mutation and infection rate is likely to worsen existing supply chain concerns, with potential global consequences. Uncertainties remain over the duration and geographic reach of the lockdowns. Furthermore, the low vaccination rates in certain parts of the world means that we are one mutation away from another global spike in rates, with consequences for the global economy amidst the ongoing impact of the Russian war. For the Fed, the decision on what constitutes a proper response is increasingly affected by key external events over which it has little control. Complete inaction risks an inflation spiral, with consequences for the American and global economy. On the other hand, rate hikes, amidst multiple stress points on the economy, risk triggering an economic recession in America with rapid global contagion. 

Conclusion: Where do we go from here? 

The year began on a confident note with calls for reining in expansionary monetary policies and the consequent inflation. However, in less than two months, the outlook is increasingly muddy. The Russian war and spike in covid cases have added undesirable variables to the global economic recovery efforts. Will the Fed act? We expect it to. The alternative is inaction, which risks further worsening the inflation situation in the US. However, we do not expect the initial calls for aggressive action considering ongoing health and geopolitical developments. Thus, rather than the long-expected 0.5% hike, it is increasingly likely that the Fed would adopt a 0.25% hike, followed by similar, higher or lower hikes, depending on the near-term developments in Russia as well as China’s response to the pandemic. Either way, for developing countries whose debts include a variable rate, the hike would be unwelcome news as they deal with the fallout of Russia’s invasion of Ukraine. 

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Disclaimer: This information in this article is NOT investment advice. It is intended for information and entertainment purposes only.

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