The Russia-Ukraine War and its Effects on the Economy

Economic Update:  No Easy Answers

Russia’s war in Ukraine is entering its fourth week. Despite recurring rumors of ceasefires and negotiated settlements the end of the war is not yet in sight. The horrific human toll of the war continues and serves as a stark reminder how fortunate we are as Americans to be insulated from aggression at home by broad oceans, docile neighbors and a formidable military. Our thoughts are with the people of Ukraine.

Economic repercussions from the war continue to be centered on commodities, notably energy, agriculture and industrial metals and gases where Russia and Ukraine are significant global suppliers. Many commodities that spiked in earlier in the crisis have pulled back from their highs but remain at very extended levels. While commodity shipments from Ukraine have reportedly been halted or severely curtailed, there have been few if any notable drops in production of Russian commodities including oil and natural gas.  Beyond pure supply questions there are concerns around transporting commodities from Russia and Ukraine to global markets.  On top of the crisis in Ukraine, we are also facing growing shutdowns in China as the country’s zero-COVID policy runs into a surge in the disease. Should these shutdowns grow or become extended it would enhance the risk that the gradual healing of global supply chains would halt or reverse. None of the factors above would likely serve to bring down surging inflation which is the most prominent challenge the economy now faces.
 
If those challenges weren’t enough, on March 16th, the Federal Reserve made good on its promise to begin hiking its target interest rate and indicated that several more rates hikes, both this year and next, are on the way. The Fed will walk a tightrope in using rate hikes and eventually balance sheet reductions to combat inflation while avoiding slowing the economy and harming the labor market.

While our base economic case remains centered on slowing growth rather than recession domestically, we think recession risks continue to build. The Ukraine crisis, supply chain challenges and inflation have exposed latent weaknesses at many points in the global economy that could break should further shocks to the system be forthcoming. U.S. consumers broadly remain well positioned. The lower half of the income spectrum faces a tougher road as excess savings have largely been drawn down. Additionally, this group is faced with nominally strong wage increases that are failing to keep up with inflation, especially in energy and food which make up a relatively large portion of their spending. This cohort will have to turn to credit use to try to maintain consumption. The upper half of the income spectrum still has excess savings and harbors pent up demand for services that should be deployed over the remainder of the year.

From an investment policy perspective, we are staying the course. Our already low relative exposure to Europe, which faces greater risk from the Ukraine crisis, has been further reduced. Our direct exposure to Russian and Ukraine remains de minimis. We have kept our asset allocation toward equities and away from bonds steady and adhered even more tightly to our preference for high quality companies. Please reach out to your advisor if you have questions.