The Russia-Ukraine conflict dominated financial headlines in February, leading to modest declines for U.S. stock indices. Interest rates continued to climb most of the month but dropped following the invasion. Mounting international sanctions have put the Russian Ruble into free-fall, as businesses and individuals rush to sell Russian assets. The U.S. economy and stock market stand in a position of relative strength vs Europe and many other parts of the world. Many U.S. corporations scaled back investment in Russia following the 2014 invasion of Crimea and the ensuing sanctions. Russia doesn’t crack the top 15 U.S. trading partners but is a major global commodity supplier. Key exports include oil, gas, steel, aluminum, wheat, platinum, and fertilizer. The war’s impact on inflation will be a concern for markets in the months ahead as supply chains face further disruption and commodity prices likely rise.
With the U.S. entering its second year of higher-than-normal inflation, the Federal Reserve faces increasing pressure to adjust monetary policy. High inflation expectations among consumers and businesses can create a feedback loop whereby wages and producer prices are negotiated higher, spurring continued inflation. This upward spiral can lead to “sticky” inflation that becomes more difficult to combat with policy actions. It’s also why the Fed pays close attention to consumers’ inflation expectations. The chart below shows survey results of consumer inflation expectations for the next one (blue) and three (orange) years. Recent results (through January) showed moderating inflation expectations, although surveyed inflation uncertainty was as high as ever. Consumers also continued to view at least some of the inflation as near-term, as shown by the lower three-year (annualized) inflation expectation.
Geopolitical events are extremely unpredictable, including the current one centering upon the question of what Putin will do next. Such occasions warrant humility and prudent risk-management considerations as opposed to grandiose predictions and panic. We continue to view inflation-driven shifts in monetary policy as the focus of markets and will be closely following how the war plays into this dynamic.
-Jared J. Ruxer, CFA, M.S.