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Picture: 123RF/DELTAART
Picture: 123RF/DELTAART

Global investors have been jolted from notions of a glide-path back to pre-pandemic norms and are once again scrambling to game another series of potential shocks along the way.

For many, the alarming threat of a Russian invasion of Ukraine, a standoff with Nato forces and the risk of another energy price explosion just reinforces an increasingly confident inflation narrative. But it could upend everything else too, throw recession risk back in the mix and complicate policy guessing.

It is a severe headache for those now trying to position in already richly priced equities and bonds. And the increasingly erratic market swings in January show a nervy disposition about the remainder of 2022.

Much of the market skittishness is clearly due to the US Federal Reserve’s hawkish turn against sky-high inflation.

The aggressive shift in Fed rhetoric coming into 2022 signalled to many that all eight of this year’s Fed meetings, including this week’s gathering, would be “live” ones in the removal of emergency supports.

And if at least four interest rate hikes and an unwind of the Fed’s bloated balance sheet are all now on the table, it leaves little room for markets to relax all year.

But the geopolitical twist in Europe, and the energy price risk it exaggerates, adds a whole new dimension — not least with the pandemic still playing out in the background.

Even before military tensions intensified in January, investment banks such as Goldman Sachs saw supply and demand dynamics pointing to a return to $100-per-barrel oil for the first time in seven years.

While this is less than 15% from Brent crude prices now, it is more than 50% higher than pre-pandemic levels. And it would also knock out a central hope of governments and central banks worldwide that energy base effects spurring decades-high headline inflation rates would quickly roll over.

The Russian standoff and risk of a full-blown Ukraine invasion ups the ante on both crude and also on soaring natural gas prices in Europe.

Inflationary? For sure. Recession too?

In a “What if?” note from Friday, JPMorgan economists Joe Lupton and Bruce Kasman sketched out what $150-a-barrel oil as soon as this quarter could mean.

They concluded that such a negative shock would more than double their estimates of annualised world inflation to 7.2% for the first half of 2022 — and virtually wipe out equivalent global growth to 0.9% annualised from 4.1% previously.

Cyclical downturns

The scenario they model, which hinged on a 2.3-million barrel-per-day drop in world crude supplies, took in the effect of more hawkish central banks — particularly in emerging economies. But it said the effect of a Russian invasion per se could even amplify this shock due to the broader financial market overspill and economic sanctions on Russia itself.

“Oil shocks have a long history of driving cyclical downturns, with US recessions often associated with oil price spikes,” Lupton and Kasman wrote. “Tensions between Russia and Ukraine raise the risk of a material spike this quarter.”

One offsetting factor, they add, is that the Fed and other major central banks have over more recent decades increasingly viewed energy shocks more as a demand suppressant than an inflation spur.

But even this may have to be rethought in the light of peculiar circumstances now.

Putting the Russian tensions and related oil and gas squeezes in the context of post-pandemic supply disruptions — as well as longer-term megatrends of demographics and climate change — the BlackRock Investment Institute says policymakers will now be forced into long-absent trade offs.

“A world shaped by supply constraints will bring more macroeconomic volatility. There is no way around this,” it said. “Unlike when inflation is driven by demand — policy cannot stabilise both inflation and growth at the same time — it has to choose between them.”

BII economist Elga Bartsch estimates that if central banks were to tighten fast just to get supply-driven inflation rates back to 2% targets, it could come at a cost of almost 10% unemployment rates.

And it’s hard to imagine such macro volatility not being matched by higher financial market volatility too.

The consensus for 2022 had, until January at least, stuck doggedly to the idea that stock prices would more than match economic growth and earnings projections to deliver another positive year — despite persistent inflation and normalising interest rates.

A reluctance to insulate portfolios with bonds that could suffer badly in a rising rates environment partly reinforced that and now complicates it wildly in the face of a sudden shock.

But there is always cash — not least while people now wait to see how central banks navigate these choppy waters.

“The Fed will be judged not by its ability to move rates up but by its capacity to avoid having to cut nominal rates all the way back to zero again and restart QE [quantitative easing] when the first external shock hits,” wrote Pictet Wealth Management’s Thomas Costerg. “This is far from being assured.”



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