The February 24 invasion of Ukraine by Russia has resulted in heightened volatility as bid/ask spreads have widened and liquidity has dried up. President Biden’s decision to punish Russia’s aggression by halting purchases of Russian fossil fuel has caused the price of a barrel of crude oil sky-rocket. West Texas Intermediate briefly touched $130 a barrel on March 7th before settling in around $106 a barrel at the time of this writing. The rise in oil is having a direct impact, as one would expect, on gas prices. While the general population is aware of the dislocations in the capital markets, the rise in the price of gasoline is a direct hit to their wallet and one that has the average citizen worried. Economic forecasters are attempting to back into the price of a gallon of gasoline should the Russian oil ban become a sustained policy, and their forecasts are frightening. Estimates are as high as $150 to $200 per barrel of oil with gasoline topping out at $8 to $10 per gallon. Should the price of a gallon of gas rise to that level, we’re fairly confident that the U.S. economy will be in a recession. As it is, the Atlanta Federal Reserve’s GDP calculator is forecasting 0.041% economic growth in Q1 2022. We wonder how the investing public is going to react to 0% economic growth after enjoying 6 quarters of “eye-popping” economic growth fueled by emergency COVID stimulus. The first estimate of that growth comes at the end of April so we have plenty to worry about between now and then.
Equities have also come under heightened volatility. Since peaking at 4800 in January, the S&P 500 has fallen by 10%, and while the pullback hasn’t been a straight line, the market action has been lower highs following each pullback. The chartists don’t like to see that sort of price action in belief that it foretells further price correction. On the other hand, from a fundamental perspective, the fall in share price is likely warranted given the prospect for lower earnings in the coming quarters. Global corporations are shuttering their Russian businesses and a halt to a 144-million-person market is certain to impact the bottom line.
Ironically, despite the ongoing inflation surge and the detrimental impact the gas price shock is likely to have on the consumer price index, short maturity interest rates continue to rise. The two-year note is peaking this month at 1.82%, more than 1.60% above the yield-to-maturity just last September. Driving that upward pressure is the belief among bond traders that the Fed will hike the overnight interest rate seven times in the next 12 months. We are highly skeptical that the Fed will have the wherewithal for such a move. Fed Chairman Powell’s testimony before Congress earlier in the month signaled that a 0.25% rate hike is likely at the conclusion of the March 16th FOMC meeting, but he left the possibility of 0.50% open. We may be guilty of being too critical of the Fed, but they conceded that inflation was a problem month ago and still haven’t gotten around to ending emergency monetary policy. That criticism is going to intensify when the rise in energy prices is factored into the consumer price indices. If nothing else, Chairman Powell has demonstrated a consistent history of bowing to Presidential pressure. Should the U.S. economy dip into recession, it’s likely that President Biden will pressure Powell to stop hiking rates and take action to stimulate the economy. Had the Fed raised rates 18 months ago and stopped quantitative easing last year, as many economists had argued, inflation would likely never have materialized and the Fed would have ammunition to stimulate the economy. But as it stands now, they’re on the precipice of inflation fighting at the worst possible time.
Given the backdrop of the terrible atrocities befalling the citizens of the Ukraine, not much attention was paid to the employment report released earlier this month, but the measure showed that the U.S. continues to create jobs at a very rapid pace. February saw 678,000 new jobs created, exceeding the forecast by more than 250,000 jobs. To put that into perspective, under normal circumstances 200,00 new jobs in a month would be considered a solid report. But economic fundamentals are, and will likely continue, to take a back seat to the aggression in Eastern Europe.
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