Ukraine Complicates Fed’s Mission

March 11th, 2022

Markets struggled again this week as the Russia-Ukraine conflict continued to dominate headlines. Sixteen days of war has now revealed the Russians expanding their offensive to the western part of the country. While Ukrainian forces have offered stiff resistance on the ground, Western nations have continued to ratchet up the sanctions on Russia. The Biden administration announced a ban on Russian oil imports this week, and the Europeans are expected to announce a plan for energy independence from Russia by 2027. With the energy market bracing for the realignment, prices have risen at the pump, adding to inflationary pressures both globally and at home. The CPI Index notched another 40-year high in February as the index rose 7.90% from the year ago period. Despite the high inflation, overall global demand remains strong based on this week’s U.S. and China trade reports. With investors focused on the Fed’s meeting next Tuesday and Wednesday, and as the situation in Ukraine continued to escalate, markets slipped for their fifth consecutive week.
Commodities Prices Push Inflation Higher
Consumers continued to feel the pressure with the CPI Index having risen 7.90% year-over-year in February, driven by food and energy prices. Core prices, which exclude food and energy, also moved higher, increasing by 6.40% which resulted in the highest reading for the index since August 1982. Gasoline prices rose 6.60% in February, which was prior to the full effects of the Ukrainian war that will be felt in March. Year-over-year, gas prices are up 38%. Food prices also rose during the month, up 1.00%. Food that was consumed at home rose even higher at 1.40%, which is troubling given that eating at home is a non-discretionary item over which one has little control. Year-over-year, food prices were up 7.90% overall and 8.60% at home. Consumers did begin to see some price relief at the dealership in February. New vehicle prices remained flat month-to-month while used cars and trucks saw prices drop -0.20%. Despite the inflationary pressures, consumers have yet to pull back on their spending. A strong jobs market and pent-up Covid demand has provided consumers with a solid foundation to maintain their spending.
Guns and Ships Don’t Mix
Global trade was strong ahead of the war in Ukraine. Strong consumer demand for vehicles and energy pushed the U.S. trade deficit to a record high of $89.7 billion in January. Imports rose 1.20%, led by shipments of vehicles, industrial supplies including crude oil and natural gas, food, and capital goods such as telecommunications equipment. Meanwhile, exports fell -1.70%. The drop was driven by a decline in consumer goods such as pharmaceuticals which analysts attributed to fewer shipments of Covid-19 vaccines as well as services for travel and transport amid the last vestiges of Omicron. China trade figures also showed strong global demand with their exports rising 16.30% year-over-year in the January-February period. China traditionally reports trade data for the first two months of the year in order to smooth out fluctuations due to their factories shutting down for the Lunar New Year holiday which falls at different times each year. Chinese imports were also strong, up 15.50% year-over-year. China’s economy could come under pressure in the months ahead. As the world’s biggest commodity buyer, China could experience some fallout from the Russia-Ukraine crisis. The uncertain environment has already prompted the country to lower its 2022 GDP target growth rate to 5.50%, the lowest annual growth target since the 1990s. Inflation is not just a U.S.-China problem, however. The war in Ukraine has disrupted shipping in the Black Sea and the adjoining Sea of Azov, which are important food and oil export routes. Reports indicate hundreds of ships are currently stranded at Ukrainian ports amid the fighting. Some of those who have managed to set sail have found themselves caught in the crossfire, struck by missiles. The precarious situation is likely to keep ships from sailing freely into the region, snarling supply chains across the globe and weakening economic growth. 
Commodities such as oil, gasoline, and metals (nickel and palladium) are raising the alarm of a global slowdown. Every time oil prices have risen more than 50% (year-over-year) over the past 50 years, a recession has followed. The recessions of the early-1970s, early 1980s, and early 1990s were all due to oil-price shocks or the monetary response to control the inflation created by the higher commodity costs. The past 30 years have been remarkably stable in terms of both inflation and energy prices, and during that time the global economy has become significantly more efficient in its use of oil. Whereas it once required nearly a full barrel of oil to produce $1000 of global GDP, today it requires less than 0.4 barrels, according to Columbia University’s Center on Global Energy Policy.  In this respect, we’re significantly more immune to the energy shocks than in the past. Furthermore, we’ve seen oil at $110/barrel, where it is today. This is equivalent to what we experienced from 2011 to 2014. Economic growth slowed but didn’t stall. Today, however, we face a multifront battle (excess demand and supply constraints) on inflation that the current geopolitical environment has only complicated. Orchestrating a soft landing in an inflationary environment is hard enough, but it is another thing altogether when the ground is shifting from tectonic forces emanating from a global trade and energy realignment. This is the world the Fed must now navigate starting with its meeting next week.

The Week Ahead

The Federal Reserve holds its FOMC meeting where it is widely expected to announce its first rate hike in more than two years. Traders will also pour over February retail sales figures for signs of continued consumer spending momentum. The producer price report rounds out the week’s economic news with businesses on the lookout for price relief at the factory gate.

Pain at the Pump

The price of gas in the U.S. hit an all-time high this week with the average price per gallon now $4.17, according to the American Automobile Association (AAA).  The average reached $5.72 per gallon in California for regular unleaded fuel, setting a new national record. California’s peak price is partially due to the Golden State’s high gas taxes and environmental regulations. Compared to a month ago, drivers across the country are paying nearly a dollar more per gallon. Prices jumped due to sanctions on Russia over the invasion of Ukraine and a ban on Russian oil and gas imports.  When adjusted for inflation, today’s fuel prices are still below their peak in 2008. In today’s dollars, the price was closer to $5.25 a gallon. The 2008 spike came at the end of a decade-long energy crisis as a result of high demand from developing economies, stagnant production, and tensions in the Middle East.
In light of these high prices, there are several ways that drivers can save at the pump.  A study by AAA showed that 16.5 million U.S. drivers wasted $2.1 billion at the pump by using premium gas unnecessarily in the past 12 months. Many drivers think premium gas is better for their vehicle, but unless you drive a car that “requires” premium gasoline, your car doesn’t need it.  AAA explained that premium gasoline is higher octane, not higher quality, and most vehicles are not compatible with high octane gas.  The majority of cars can run just fine on regular and mid-grade gasoline.
Here are some other tips from a variety of experts on how drivers can curb their gas bill.
  • On average, Mondays are often the cheapest days to fill up, even with loyalty or membership programs, according to Gas Buddy, an app that helps people find the lowest-priced gas in their area. Gas prices can vary as much as 10 cents to 15 cents per gallon within a few blocks or miles. In addition to GasBuddy, there are other mobile apps including Gas Guru, Waze, and the AAA Mobile App that can help drivers locate the lowest prices near them.
  • Experts recommend keeping tires inflated properly and regularly changing oil and air filters to help your car burn less fuel. 
  • Stay calm and drive on. Research by shows that avoiding rapid acceleration, high speeds, and braking sharply can save up to 38% on gas.
  • Check to see if your credit card has any deals on gas purchases. Some cards will give you double points or cash back. Consider signing up for loyalty programs, reward programs, and gas cards that offer gas perks. 
  • Pay cash if you can. This sounds contrary to the advice above, but many service stations charge less if you pay with cash or a debit card. 
  • Avoid idling. Leaving the engine running while the vehicle isn’t moving uses more fuel than restarting the engine, according to State Farm. AAA says idling burns one gallon of gas per hour. Turn your car completely off to save fuel and cut down on emissions.

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