There is a risk now that the escalation of the Russia-Ukraine conflict will push oil past $100/barrel. It could be argued that any conflict would be negative for global growth prospects, but central banks globally, including the ECB, will have to prioritise combatting inflation. The jump in the German PPI ex-energy (+2.2% m/m) shows prices pressures have broadened.
The Fed, the ECB and the BoE are already behind the curve. If they cannot rely on a deflationary contribution from statistical base effects to bring inflation back in-line over the next year, they will have to be more aggressive in their rate hikes earlier on. This is the problem with accelerating CPI inflation above 7% as is the case in the US. At such high inflation rates there is no margin for error and no room for any ‘exogenous’ events.
For the Fed, the rate of inflation will be uncomfortable. There are sectors of the economy where price increases have simply got out of hand and have surpassed the inflation of the 1970s. Construction is a case in point (see yesterday’s commentary, A few Fed Funds rate increases unlikely to have a material impact on housing, February 22nd 2022).
The impact of a Russia-Ukraine conflict on US corporate earnings is forecast to be limited, but for Treasury yields this is not the case at all. Our forecast for S&P 500 to 4,000 by the end of February may have been a bit premature. But we still think the risks remain to the downside, because of a more aggressive Fed, which could still hike 100-125 bps by June (our base forecast). The current situation in Russia-Ukraine strengthens this view. But the survey data on service sector prices in any case will force the Fed to move faster. The labour market is so tight that some companies in the US are switching to more frequent (quarterly) pay reviews.
