Daily Comment (April 8, 2022)

by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM EDT] | PDF

Good morning! Today’s report opens with the economic fallout from the Russian invasion. We then cover a few central bank updates. Economic and policy news follows, and we close with our COVID-19 coverage.

Less than two months into its invasion of Ukraine, Russia is already feeling the pain of the sanctions. Russia expects to be headed toward one of its worst economic crises in recent history. According to a Bloomberg survey, Russia is on track to contract for two consecutive years for the first time since the breakup of the Soviet Union. In an unscheduled decision, the Central Bank of Russia cut its key rate by 300 bps to 17%. The quick slash of rates suggests that the government has started to change its focus from stabilizing the financial system to stimulating the real economy. Although policy rates remain far above their level prior to the invasion, it does signal that the central bank still has some tools at its disposal to soften the blow of the economic sanctions. That being said, as food prices rise globally, we suspect Russia will likely have to be very cautious with its policy accommodation as it is forced to decide how much inflation and unemployment it is willing to tolerate.

As Russia looks for ways to cushion the impact of the economic sanctions from the invasion, the West tries to ramp up the pressure.  On Thursday, Congress officially passed a bill that would ban Russian commodities. Additionally, Congress approved removing Russia’s and Belarus’ most favored nation status, a move that could potentially expose the countries’ exports to tariffs. The U.S. has started to enforce its export controls against companies sending tech made in the U.S. or containing parts made in the U.S. The move comes as the government tries to ensure that Russia lacks the equipment needed to maintain its aggression in Ukraine.

Germany is also trying to cope with mounting pressures from the war. On Thursday, Germany’s ruling coalition agreed to a stimulus package to support domestic companies impacted by economic sanctions. In the commodity sector, German regulators have asked banks and trading partners to continue to do business with Russian gas firm Gazprom.  In a letter, the Federal Network Agency, the German regulatory office for electricity, gas, telecommunications, post, and railway markets, warned that shunning the company could force it into bankruptcy, leading to further disruption in the gas market. Therefore, it appears energy concerns have taken a back seat to the Ukraine conflict. Germans are pushing their government to do more to help Ukraine defend itself from the Russian invasion. A survey by ARD-DeutschlandTrend showed that 45% of respondents believe that the government’s response to the invasion is insufficient, with only 37% holding the opposite view. The increase in public support suggests the government has amassed a lot of political capital as it tries to deal with its changing relationship with Russia.

Since the start of the war, we have been paying close attention to Germany because of its strong dependency on Russian energy. In our view, wars are fought by the public just as much as by the military. As long as the public supports the government in its effort, a war will be able to continue. However, if the people express an unwillingness to pay the economic cost needed to maintain the war, the ruling government risks being ousted., German support of the invasion is likely a sign they will continue to support Ukraine in its war effort, but sentiment may change in the winter when Germany feels the bite of rising energy costs. In response to energy concerns, the country appears to be building its inventory, but it isn’t clear whether Germany will have enough storage to prevent an energy crisis during the colder months. Russia also has a public perception problem. Although it can stop media outlets from showing unfriendly news about the war, it cannot stop people from mourning the death of family members fighting in Ukraine. Thus, there are still risks on both sides regarding maintaining their position. With respect to markets, this could mean conditions remain unfavorable to equities.

Central Bank News

St. Louis Fed President James Bullard stated he would like the Fed to raise rates sharply in order to counter inflation. He also pushed for the policy rate to be near 3-3.25% by the end of the year. History suggests that the Fed could cause havoc in the financial system if it follows this recommendation. Over the last three decades, the Federal Reserve has not been able to raise rates above the preceding business cycle’s peak without triggering a market issue. The previous business cycle was not an exception. Although it is true that the pandemic forced the Fed to push rates back down to zero, there were also problems within the repo market prior to that happening. As we mentioned yesterday, we suspect the Fed is still taking a wait-and-see approach to inflation. Thus, there remains a chance that the Fed could slow the pace of rate hikes as new economic data is released. We are paying close attention to the CPI and GDP reports because we suspect that a deceleration in economic growth or inflation could lead to a rethink on the current pace of policy hikes.

Economic and Policy News

  • Treasury Secretary Janet Yellen stated it would take years to develop a central bank currency if the U.S. decides to create one. Following President Biden’s signing of an executive order on cryptocurrency, the administration has been studying the possibility of issuing a national digital currency. One of the goals of issuing a central bank currency is to provide low-income households with more access to the banking system.
  • The UN General Assembly voted to suspend Russia from the Human Rights Council. In a previous vote condemning Russia for the humanitarian crisis, the number supporting its removal was greater. The outcome suggests that more countries are feeling uncomfortable choosing sides between the West and Russia over the conflict in Ukraine. Prior to the vote, Russia stated it would view support for its removal as unfriendly, implying that Moscow could retaliate by limiting energy exports.

COVID-19: The number of reported cases is 495,763,966, with 6,169,643 fatalities. In the U.S., there are 80,289,237 confirmed cases with 984,571 deaths. For illustration purposes, the FT has created an interactive chart that allows one to compare cases across nations using similar scaling metrics. The CDC reports that 708,450,345 doses of the vaccine have been distributed, with 563,999,093 doses injected. The number receiving at least one dose is 255,975,678, while the number of second doses is 218,135,613, and the number of the third dose, granting the highest level of immunity, is 98,424,742. The FT has a page on global vaccine distribution.

  • China continues to be the current epicenter of COVID-19, with over 21,000 cases in Shanghai on Thursday. Beijing is facing growing pressure from the public, who are experiencing lockdown fatigue due to the country’s zero-COVID-19 policy.

View PDF