US Federal Reserve chairman Jerome Powell’s fight against inflation will almost certainly be made harder because of Russian President Vladimir Putin’s escalation of the war on Ukraine.
Powell and his colleagues on the Fed’s Open Market Committee called out Russia’s influence on inflation in a statement released on Thursday.
“Russia’s war against Ukraine is causing tremendous human and economic hardship. The war and related events are creating additional upward pressure on inflation and are weighing on global economic activity,” the FOMC said.
The loss last week of 4830 square kilometres of territory in the Kharkiv region from an effective Ukraine counterattack has made Putin increasingly desperate and unpredictable.
Russia has the power to cause a major negative shock to the global economy from limiting supply of its energy products, the Bank for International Settlements says.
Russia, Saudi Arabia and the US are the only jurisdictions with daily output above 10 million barrels per day, with each accounting for about 14 per cent of global production, said the BIS quarterly review published this week.
“About half of Russian production is directly exported, representing 10 per cent of global exports of crude oil,” the BIS said.
“The rest is an input into the production of distillates, with Russian refiners accounting for about 15 per cent of global exports of diesel oil and heating oil”.
The reliance on Russian oil has not been helped by the actions of advanced economy energy companies, which have been winding back upstream investment in oil and gas since 2015, according to the BIS.
Upstream investment by advanced economy energy companies has fallen by an average of 30 per cent compared to 2019.
A Russian ban or restriction on oil exports in response to the continued Western supply of weapons to Ukraine, would have a flow on effect to food inflation because of the incentive for gasoline producers to use biofuels.
BIS analysis found that corn, which is a major input in the production of ethanol, is in strong demand from gasoline blenders. About 40 per cent of the US harvest was used to make ethanol over the past five years.
The prices of corn and oil have thus moved in tandem since the mid-2000s, with occasional large deviations that eventually subside over time,” the BIS said.
A shift to increased use of ethanol made from corn would moderate oil prices. But higher corn prices would spill over to other agricultural markets.
“As corn competes with soybeans for acreage, changes in corn prices usually are transmitted quickly to soybeans,” the BIS said. “Furthermore, both crops are used as livestock feed stuffs.
“In sum, persistent disruptions in global energy markets can spill over to raise the prices of a wide range of agricultural products through a variety of channels.”
Higher inflationary forces caused by extreme Russian actions would force the Fed to maintain a higher-for-longer strategy on official interest rates to fight inflation. It wants to raise its official interest rate to 4.5 per cent by the end of the year.
Signs US inflation is coming under control
The signs of Putin becoming more belligerent and less rational, come amid signs that US inflation is coming under control.
The drop in gasoline prices and easing food inflation should push down headline CPI in the next two months, says Paul Ashworth, chief US economist at Capital Economics.
He said this week that supply shortages had normalised and the Capital Economics product shortages indicator was now suggesting core goods inflation could fall back to 2 per cent before the end of the year, from 7 per cent in August.
Ashworth said that core services inflation was fuelled by rising rents, but the latest leasing data showed rent rises were slowing markedly. He pinpoints lower airfares and hotel rates in the US as signs of lower inflation.
The wildcard for global markets remains Putin.
“Investors have gone from believing that Russia is likely to crush Ukraine at the beginning of the war to a consensus view that the most likely scenario will be a prolonged stalemate to discussing a possibility of Ukraine crushing Russia,” says Macquarie’s strategist in New York, Viktor Shvets.
He says one extreme outcome that has not yet been discussed is the impact military defeats and a regime change might have on the Russian Federation itself.
“Most investors do not realise that Russia is indeed a federation of more than 200 nations and 100 distinct language groups, that have little or nothing in common with either East Slavic languages or the Orthodox religion,” Shvets says.
“The best way to look at Russia is as a mini-Soviet Union-type empire that could be as prone to nationalism and desire for decolonisation as any other part of the world.
“Minorities occupy 41 per cent of Russian territory (where most resources are located) and account for 20 per cent of the population.
“Especially troublesome are autonomous areas around the Volga and the Caucuses. When the USSR broke up, two of the largest autonomous regions (i.e., Tatarstan and Chechnya) refused to sign a federation treaty, which led to a protracted Chechnya war.
“A possibility of a major nuclear power breaking up would be a nightmare.”
Shvets believes extreme outcomes can be avoided, but the risks of that happening have increased over the past week.
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