Moody's Talks - Inside Economics

Bonus Episode: Update on Russian Invasion of Ukraine

Episode Summary

Mark, Ryan, and Cris welcome a number of Moody's Analytics colleagues from around the world to discuss the latest developments in the Russia-Ukraine war and what this means for the global economy.

Episode Notes

Mark, Ryan, and Cris welcome a number of Moody's Analytics colleagues from around the world to discuss the latest developments in the Russia-Ukraine war and what this means for the global economy.

Full Episode Transcript here.

Episode Transcription

Mark Zandi:                      Welcome to Inside Economics. I'm, Mark Zandi, the chief economist of Moody's Analytics, and this is a special bonus podcast about Russia-Ukraine. A lot going on. It seems like things are moving minute by minute and I thought it'd be useful to give you, the listener, an update with regard to how we think things are playing out and what it means for the global economy. And to that end, I've asked a number of my different colleagues to join us from different parts of the world to give you a sense of how we think the Russian invasion of Ukraine is playing out in these different parts of the world.

                                             So I won't introduce my colleagues yet. We'll introduce them along the way, but let me begin with Gaurav Ganguly. Gaurav is leading the way in Europe. He's head of EMEA economics, European, Middle East, African economics, and has been paying very close attention to this. So Gaurav, can you just give us a sense of what's going on now and how you're thinking about how this is going to play out for the European economy?

Gaurav Ganguly:             Hi. Hi, Mark, and thanks. It continues to be a very dark time for Europe. The war that Russia has launched against Ukraine is entering what appears to be a very brutal phase right now, given that it has made less gains than it probably had hoped to make in the first week. There are reports of civilian casualties and economic destruction. We could actually be entering a phase where we see very high civilian casualties. There's a clearly a humanitarian disaster in progress. Reports of half a million refugees are more pouring into Poland and other East European countries. So it is a very dark moment in European history, I think. We have reports of Eastern city of Kharkiv and the rocket attack, reports of cluster bombs being used, and Russian troops have actually taken over parts of the Northeast and South of the country.

                                             The West has responded by imposing sanctions. U.K., U.S., EU, various other countries have imposed wide-ranging sanctions and these are too lengthy to list, but it's worth just highlighting some of these, given that these are having a significant impact on the Russian system. The EU has excluded several Russian banks from this fifth payment system. The U.S. has imposed significant sanctions on two of the largest Russian banks, Sberbank and VTB and removed the ability to transact in U.S. dollars. U.K., U.S. and the EU have frozen assets of the Russian Central Bank. That's quite significant because of the 630 odd billion of foreign reserves that the Russian Central Bank has. About 50% is in the currencies of these three regions. Russian aircraft can't use EU airspace and various individuals. A number of individuals and oligarchs have been sanctioned, raising concerns around property markets in particular parts of Europe, such as London and Switzerland.

                                             Asset prices have also moved quite a lot, as you can imagine, over the last couple of weeks. A focus on oil and gas, which are primary drivers of inflation in Europe. Certainly, I'm going to talk a little bit about what we are seeing, early signs that we are seeing in Europe. Brent is trading at about above $110 a barrel right now. It's actually up about 12% since the 24th of Feb when Russian forces launched their attack on Ukraine. European gas prices have spiked much more. So they're actually up about 80% since 24th of Feb and are currently trading around €170 per megawatt hour. That's very high. Back in December of last year when there was a temporary stoppage in one of the gas pipelines from Russia to Europe, gas prices spiked to close to €200. So the current price is really another very high spike and it's quite alarming to see.

                                             Equity markets in Europe are not doing too badly. The FTSE is down a bit, EURO STOXX's down a bit. The reports that EURO STOXX will actually remove various Russian companies from the index and actually Russian companies, particularly Russian banks in Europe, listed in Europe have seen their equity pretty much go to zero. In fact, Sberbank Europe has ceased trading and will be liquidated. So quite a lot of impact from the sanctions and also uncertainty around oil and gas supplies, which is affecting oil and gas markets and has the potential certainly to impact quite heavily on European inflation. Europe inflation came out... February inflation came out at 5.8% here on Europe. That's not reflecting the current situation. Of course, that's just reflecting the uncertainty that has led to a ramp up in gas prices over the course of pretty much all of last year.

                                             That 5.8% increase in headline inflation, in headline prices also has underlying at a 31% increase in energy prices on the year-on-year basis. It's a very significant increase in energy price inflation. So there is now a heightened sense of concern around the possibility for European inflation to continue to rise. So I'll stop there because there's a lot to talk about around this, but this is a very high level what's been happening over the last seven days. Lot of uncertainty around the conflict and the war, white sanctions in response, moves in oil and gas markets and concerns in Europe, particularly around inflation. Potentially around supply, I should probably add that as of now, Russia continues to send gas into Europe.

Mark Zandi:                      Great. Yeah. Nice. Thank you for that. And obviously very disconcerting. Let me focus a bit on energy, oil, because that is the most obvious principle link between what's going on in Russia-Ukraine and the rest of the world. And oil prices are up. And I'd go back a little further back in time before Russia had actually invaded because energy markets started discounting an invasion long before that. So my sense is that prices now... So you said Brent's 110 or over 110 while WTI, West Texas Intermediate is about the same. A little bit lower than that. There's a bit of a spread. That's up about, I think at this point, probably more like 30 bucks a barrel from where we were before Russia-Ukraine really got on the radar screen here. I think that's kind of the delta increase in oil and gas prices.

                                             In our outlook, our baseline outlook, our most likely scenario, and obviously there's a lot of scenarios here, some of which are pretty dark, a lot of downside risk, but in the baseline, we're assuming that the invasion stops in Ukraine. That Russia doesn't go beyond that and that there is no disruption, significant disruption to Russian oil, natural gas, or other commodity supplies to the market. If that's the case, then our expectation is that oil is peaking now, roughly speaking. Maybe not on a day to day or intra-day basis. It can obviously go higher given the uncertainties here, but that this is roughly the peak in price. And that by summer, and certainly by the second half of this year, because of these higher prices, we'll see some softer demand for oil and natural gas and other energy and some increase in supply because frackers here in North America can make a lot of money at this price and I would expect OPEC, Saudi in particular, to pump [inaudible 00:07:58].

                                             Tomorrow we might see Iran come on with some oil, that we'd see prices start to come in. That's how we're thinking about things in the baseline view. Does that make sense to you, Gaurav? Does that sound roughly right? Well, first of all, did I characterize the outlook in your view in the way that you think about it and is that feel like a pretty good baseline scenario?

Gaurav Ganguly:             I think it's fair to say that in our baseline, we don't envisage any lengthy disruption in oil and gas supplies. Markets are going to be unsettled for some time to come over the next few weeks, maybe even a couple of months. That's very likely, but we expect Russia to continue to supply oil and gas to Europe and to the rest of the world. And certainly from what we've seen from sanctions thus far, sanctions have been very carefully crafted to exclude energy. That's said, there's some tension right now. So we probably heard that various European energy companies are shunning rationale and self-functioning themselves, if you like. And that's an interesting development and we'll see how long that takes to normalize, but certainly, it's an interesting development that Europe is choosing on its own accords to actually walk back little bit from Russian oil. We'll have to see what that does to markets, but I think it's fair to say that in the baseline, we would not envisage any significant disruption in Russian oil and gas supplies and that OPEC and U.S. would start to compensate and this would lead to oil prices coming back in.

Mark Zandi:                      And why are they self-sanctioning? I mean, this is a surprise to me. Over the last 24 hours, this is starting to happen, but what's going on? Why are Western oil, energy companies shunning Russian oil? What, what's behind that?

Gaurav Ganguly:             So there are probably a few reasons to this. One could be that it's actually they were quite uncertain as to how they might make payments for their oil. I've understood that shipping vessels particularly, so this is oil going containers rather than pipeline oil into Europe, that container companies and the owners of vessels are reluctant to transact with Russian companies to transport oil, because they're not quite sure of the incidence of sanctions, whether it affects them. So they're holding back, and some of it, of course, their reputational reasons around it in Europe are not actually wanting to touch Russian oil at this stage. So probably a combination of factors. Some of these issues might resolve over time. Clarity over how the payment system might work, clarity around sanctions, et cetera, these might just resolve over time.

Mark Zandi:                      Right. Okay. Let me bring in a few of our other colleagues to weigh in on this. Cris deRitis is the deputy chief economist. Ryan Sweet's the director of real time economics, and also Jesse Rogers. Jesse manages a lot of our emerging market analysis. And obviously emerging markets are critically dependent on energy and other commodities. Hey, Cris, Ryan, Jesse, anything to add particularly on the oil, energy front that you think is important? I mean, obviously Putin could decide to cut off oil and energy supplies to the rest of the world.

                                             We're assuming he won't to do that because that's cutting his nose despite his face. I mean, the Russian economy is reeling and that would just completely send it down the rabbit hole. So we're assuming that he won't do that, but that's possible. And we're assuming that these efforts to self-sanctioning iron themselves out, but do you think those are reasonable assumptions? Anything to add on the energy front? Cris, do you have any views on this? I know you're a little bit more bearish on oil prices than what I just expressed in our baseline.

Cris deRitis:                       Sure. I put a little bit more weight on the downside risks here. Right? You ascribe to some rationality to Putin's decisions here regarding restricting oil flows, but that we're dealing with a non-rational or seemingly non-rational actor here. So it's certainly plausible. I also question how quickly supply response can actually come online. Certainly, there's a lot of incentive here for producers to pump or to explore, but we still have supply chain shocks that we're still recovering from, from the pandemic. Those could certainly weigh on the ability to ramp up very quickly. So I think the supply will come, but I wonder how quickly it can actually get to market.

Mark Zandi:                      Yeah. So as I said, we're assuming that 110 is the peak and we hang at these high levels for at least the next few months, probably through midyear, and then prices come in quickly in the second half of the year. You think that's a pretty good baseline view, or you take much Umbridge with that or...

Cris deRitis:                       That's a baseline.

Mark Zandi:                      That's a baseline, but there's a lot of downside risk here.

Cris deRitis:                       Yeah. Exactly.

Mark Zandi:                      Yeah. That makes sense.

Cris deRitis:                       I think.

Mark Zandi:                      Okay. All right. Ryan, Jesse, anything else on the energy oil markets you want to weigh in on? Anything we missed?

Ryan Sweet:                      I mean, OPEC met today and they announced that they're going to increase daily output, but they've been having a hard time meeting the past targets, but there is the supply response coming.

Mark Zandi:                      Yeah. And correct me if I'm wrong, but the Saudis and I think the UAE, the United Arab Emirates, they actually do have excess capacity to produce if they had to. I mean, if other OPEC producers couldn't step up, can't meet the increase in their quota, because they just don't have the capacity or the ability to do it, that Saudi could do that. Is that right?

Ryan Sweet:                      Yeah, that's correct. And if you're looking at the U.S., active rotary bridge counts are still really low. And I understand Cris' point about supply chain issues, but that hopefully we can iron that out and we should see a big response, which we have at least in the last 10, 15 years when oil prices jump, you can start to see a lot of investment in mining shafts and Wells in the U.S.

Mark Zandi:                      Yeah. I have noticed in the weekly rotary rig data for the U.S., it has taken off. It feels like it's gone to a whole nother level of increase here. So it's rising pretty quickly, and which would you would expect given the high price and feels like it's moving in the right direction. Yeah. Okay. All right. Jesse, anything on the energy front you want to bring in?

Jesse Rogers:                    One thing I'll just add on the energy front with respect to EMS is there are a huge differential impact for inflation. Ryan, you are talking about the impact on inflation for Europe and for EMS, energy is just a much larger weight in the consumer basket. So inflation risks are a lot higher and I think that's really important to keep in mind as we go forward and think about possible impacts going forward.

Mark Zandi:                      So let's turn us right back to Europe to get a better sense of what's going on there. I was just on a call with a number of EU officials and they pointed out a couple of other vulnerabilities that Gaurav, I'm curious as to what you think. One was around refugees, Ukrainian refugees. They're anticipating a lot of refugees coming from Ukraine into the rest of Europe. And of course, where these refugees go is going to be quite varied across Europe, but this is going to be a significant issue, and I'm wondering what you think about that. And then they also downplayed the financial links between European banks and financial institutions and Russian banks and financial institutions.

                                             I was looking at some data from the Bank of International Settlements, and just for context, it showed that at the end of last year, I think it was the third quarter of last year, the last data point, U.S. banks had approximately $15 billion of claims on Russian banks, whereas European banks, and this is EU plus the U.K., have something closer to $90 billion in claims on Russian banks, all of which are at risk at this point. But is that a big deal or something to be worried about? And what are some of the other... I threw those two things out, refugees and the banking links. Are there any other linkages between Europe and Russia that you think might be important to just consider here and put on the table as potential vulnerabilities?

Gaurav Ganguly:             So the refugee problem is definitely one that Europe needs to consider. The reports of millions of people having been displaced currently in Ukraine as a result of the war, and I think I mentioned right at the outset, reports of about half a million pouring across the border into Eastern Europe. Europe needs to resettle refugees. And it's not just the EU we're talking about here, even in the U.K., rules around Ukrainian refugees and the right to enter, the ability to enter the U.K. have been relaxed. So it's clear that European countries are going to accept refugees. They will be settled across different parts of the EU over time, I would imagine. And I would also imagine that at least for now, refugees will be holding on to the hope that they're able to get back to the Ukraine someday and that their stay in the EU is temporary, but of course, we have to wait and see when the tug of war recedes and what the lay of the land is as to what will happen there.

                                             It's also interesting in the context of the politics of Europe and the politics of the U.K., which has also been less welcoming towards refugees in recent years, but this war has changed that view. I think is very clear support for Ukrainians and very clear desire to take Ukrainian refugees in and give them food and shelter they need at least for a period of time. So that's the situation on refugees as I can see it right now. On banking links, this has been studied in some depth. There has been quite a lot of speculation about this for months, I suppose, but we mustn't forget that Russia, Russian organizations, Russian banks have been subject to sanctions or sanctions regimes since 2014 and Europe has withdrawn to a large extent from its engagement with the Russian financial system. So it is much less of a deal than it used to be.

                                             There are some European banks that are more exposed than others. In Hungary, for instance, or in Austria, and even one or two institutions in France, but for none of these, is it an immense deal? And it's certainly not systemic from a Eurozone perspective. So we expect issues to arise in particular, in parts of the banking system. We've heard reports of certain banks suspending dividends, et cetera, because they're concerned about their Russian exposures, but we don't see this as being systemic for the Eurozone financial system at all. Russian corporates, Russian banks, their listings in European markets, I mean, those days are over. We don't expect to see debt equity offering in Europe for a long time to come. It's very unlikely that sanctions regime will be lifted anytime soon. I would be bearish on that, and also in the current context over the last few days, Russian entities listed in Europe have simply seen values of debt and equity wiped out, which of course is harmful for certain investors.

                                             I think the third thing you also asked if there any other things. So one of the interesting side links that comes out, things like localized property markets impact, London, for instance, has a fair bit of property in the hands of Russian investors and these Russian investors, no doubt are looking to accept these properties as we speak. Switzerland is another area where we have a fair bit of property investments by Russians. So the ability of Russians to continue to hold onto these properties or perhaps transact [inaudible 00:20:23] and fire sales some of their properties, that's likely. At least in the U.K., that's probably fairly limited impact on property markets outside of that specific region of Central London. In the longer term, we would expect that flows simply change scope. The way in which Russians have invested in Europe, that's just going to change. Those days are simply over. So we should not expect to see a resumption of that.

Mark Zandi:                      Great. Okay. Well, that's helpful. So just to put a number on our forecast for Europe and here I'm mostly thinking about the EU, the European Union, in our baseline and under our baseline assumptions about how all this plays out is that European real GDP growth this year in calendar year 2022 will be about a half a point, maybe a little bit more than half a point below what it was prior to all of this mess. Does that feel about right to you at this point, Gaurav? Are you feeling good about that expectation or are things getting darker for you?

Gaurav Ganguly:             We've been thinking about this for a while and I think we still hold that view. Our February baseline forecast for 2022 for the Eurozone is about 4% growth. So growth softening this quarter, next, and after that, that's inevitable, I think. Half a percentage point feels about right. There's a fair bit of uncertainty around this. So I wouldn't be surprised to see it get slightly better or even get slightly worse, but as things stand right now, ballpark a half a percentage point reduction in 2022 growth feels like the right sort of direction of travel for the baseline.

Mark Zandi:                      Okay. And before we move on to the rest of the world, let's just quickly talk about Russia and Ukraine. Obviously for the Ukrainian economy, this is just complete catastrophe. I can't even imagine what this means for that economy. For the Russian economy, it feels like they're just gone into the abyss here and it doesn't feel like there's any way out. I mean, as long as Russia is in Ukraine in a significant way, meaning occupying Kyiv or Kharkiv or big parts of Ukraine, it doesn't seem as if the U.S. or Europe or other Western or other economies are going to change their sanctions.

                                             The sanctions are going to remain very tight. It may even get tighter here as we go forward. It feels like every time I look at a website, I'm seeing another company saying that they've stopped shipping shoes or shipping iPhones. People are just cutting off their links with Russia and I don't think there's any going back here until the Russians figure out a way to leave Ukraine. So that feels like there's nothing but negative numbers and big negative numbers for the Russian economy for the foreseeable future. Does that sound right to you? Or does that make a make sense to you?

Gaurav Ganguly:             I guess so. I think the issue here is one of uncertainty. It's really hard to see how bad it's going to be in the near term and in fact, it's easy just to make it very, very bad and then make it worse the next day. So we've also got a hold back from that. I think Ukraine clearly, huge amount of devastation going on. And as I was pointing out earlier, we seem to be entering a new, more brutal phase of this attack with Russia launching all [inaudible 00:24:03] cities, so killing people and also damaging infrastructure, ruining economic structures, destroying cities, et cetera. That's a huge loss to output. I mean, currently, I would imagine that industrial production is just all geared to its supporting the military effort and any other kind of production, any other kind of service, it's just ground to ahold.

                                             So in the immediate, things that clearly fallen of a cliff, but even looking ahead, it feels like with the kind of devastation that the country is likely to sustain, the road back is difficult. Now, if these returns in a positive way and Russian forces pulled back or there's a Ukrainian victory, I could really see a very big, international reconstruction effort kicking in, which would be very positive for the country. So there's hope there. In darker scenarios where that doesn't happen, then this could be a very nasty, long drawn out outcome for Ukraine and it's people. Russia, I think you are right. It's become an international pariah state. The actions of the last week have really been very egregious. There's no way out for Russia right now, unless as you said, it completely withdraws from Ukraine, but even then, given what has happened over the last seven days, there'll be outstanding issues around war crimes, against humanity reparations to be paid, et cetera, et cetera, which makes it really hard to see the way forward for Russia.

                                             It feels like they've become an international pariah state. They will stay that way for a long time to come. Russia is just completely isolated from the world economy and a lot of countries that will not want to do business with it. Somehow [inaudible 00:25:42] and as long as it has fair amount of power in global commodity markets for oil, gas and various other commodities, there will be countries that will be willing to transact with Russia, even those that have imposed very strict sanctions against it. You don't forget that even back in the worst part of the Soviet Union, Russia did send its oil and gas into Europe.

Mark Zandi:                      Yeah. Okay. Fair enough. Hey, let's move on. And before we talk about what it means for different parts of the global economy, let's talk about the rest of the commodity markets. I mean, because Russia and Ukraine export oil, natural gas, but a lot of other metals, everything from titanium to palladium, various gases like neon, agricultural products like wheat, I believe corn as well, and Jesse, can you give us a sense of what's going on in some of these other commodity markets in terms of... We're seeing what's happening very clearly in the oil market. We're seeing what's happening with natural gas, particularly to Europe. What about these other commodity markets? How are they performing? What's going on with prices?

Jesse Rogers:                    When you look at non-oil commodities, whether you're looking at industrial metals or agricultural prices, and the key differentiator is goods or commodities that Russia directly exports, and that Russia's a really big player. So aluminum prices and wheat prices are at record highs, surpassing heights during the commodities boom of the past decade, whereas the increase in copper, copper prices have increased is sort of a bellwether for non-oil commodities as a whole, but they aren't quite as high as they earlier this year. The long and short of it is even if we come off of these peak's commodity, non-oil commodity prices are going to remain high and that's going to be another headwind to global supply chain issues in inflation more broadly.

Mark Zandi:                      I know, Ryan, you look at these market's too, pretty careful. Anything you want to point out in terms of pricing or any disruptions to supplies? Anything at all in the commodity side?

Ryan Sweet:                      No, I think Jesse covered it all.

Mark Zandi:                      Okay. Okay. Very good. All right. So let's now talk about what it means for the U.S. economy and Cris, my sense is that it should be small. Again, in our baseline world where we're assuming Russia doesn't step outside of Ukraine and that there's no significant actual disruptions to energy or other commodity supplies, that eventually the risk premium in these markets will start to come down. We'll get more supply and we'll start to see prices come in and things will moderate. And the U.S. is very energy independent. Higher oil prices are a negative, but a very small negative because now obviously it hurts consumers, American consumers, particularly low-income consumers, but it benefits the energy industry.

                                             So the net of all that is a small negative. What do you think? Are we being too Pollyannish about all this? I mean, I talked about the banking links. They're very small. The trading links are very small. There's some concern that maybe if Europe weakens, there’s going to be some blow back on the U.S. because of the trade with Europe, but that's all... When you do the arithmetic there, that doesn't add up to a whole lot. So what do you think? Are we being overly optimistic here with regard to the impact on the U.S. economy?

Cris deRitis:                       I think we might be. I think again, there are significant downside risks some of which we haven't, I think, uncovered yet. We're only weak into this war. I worry about consumer confidence or confidence in general, right? If this is a protracted long war that grinds on week after week, month after month, I think that could certainly affect consumer psyches and also the expectations as we think about inflation, right? So I do worry that Fed's going to have to take more aggressive actions, for example, around inflation that would certainly cut into growth. So I don't want to adopt the darkest scenario as the baseline quite yet, but I would certainly be more cautious at this point. The only upside I see is some regime change, right? Based on what we've just discussed here, I don't see how this ends otherwise in a positive light. And I don't see that happening very quickly or very easily.

Mark Zandi:                      Yeah. Right, right. In terms of the downside risk, you mentioned inflation expectations. I mean, obviously they're already pretty fragile coming into this because of the pandemic effects and high inflation and felt like inflation expectations certainly for consumers was pretty high, and this may... What you're saying is because particularly gasoline prices, because they pay such an outside role in people thinking around inflation expectations, that this could cause what central bankers would say, what The Fed would say, an anchoring of inflation expectations. And when that happens, you run the risk of getting into this wage price spiral and The Fed and other central banks will not tolerate that. Then they'll step on the brakes a lot harder than what we expect and that raises the specter of a recession later this year going into 2023. That feels like a pretty significant risk.

Cris deRitis:                       Yeah. I also worry about some of those other commodities that Jesse mentioned, the metals and whatnot. And I think oil, actually, we have a little bit more flexibility. There are other countries that can increase production and fill in the gap. For some of those other metals, I don't know that we have as much flexibility. I think we are quite dependent on Russian exports. So that's just another supply chain related risk I see out there.

Mark Zandi:                      Yeah. Good point. The other thing I would bring up is the stock market, right? The stock market is down a little over 10% now from its all-time high, so at the beginning of the year before all this mess began, which by itself is no big deal, right? I mean, because it was up 30% last year and 10% is like a garden variety correction that I don't think I'd worry too much about, but you could construct... Because the market is pretty highly valued and there was a lot of sign of frothiness building in, you could see and it was pricing in nothing but good news going forward and clearly Russia-Ukraine is nothing but bad news that we could see prices fall a lot more down 20, down 25, down 30. That could be a problem.

Cris deRitis:                       Yeah. Then definitely you're talking consumer spending effects, people pulling back and worried about their nest eggs.

Mark Zandi:                      Yep. Yep. Okay. All right. Okay. I was going to say one other thing about that, but I can't remember what that was.

Cris deRitis:                       Maybe Fed policy? Want to turn to Ryan or...

Mark Zandi:                      Oh yeah. That was it. Yeah, absolutely. So Ryan, because of our... Again, I keep going back to the baseline. It's the stake in the ground that we're thinking about these things. There's this push and this pull, I mean, in terms of monetary policy. I mean obviously the push is that we've got higher inflation and potentially higher inflation expectations. The pull, or maybe it's the other way around. Push or pull, you get my drift.

Ryan Sweet:                      Mm-hmm (affirmative). Yeah.

Mark Zandi:                      The other is it's going to hurt growth. It's a classic supply shock that dis-complicates things enormously for central banks and The Fed. What does The Fed respond to? The weaker growth or increased uncertainty or the inflation? So I think we've landed on, well, the crosswinds kind of wash each other out and we have no change in monetary policy. Is that right?

Ryan Sweet:                      That's correct. And if there's any risk, it's just the risk that The Fed does more because they have a zero tolerance policy when it comes to inflation. So if we get some upside surprises relative to their forecast on the inflation front, then they're going to put their foot harder on the brake, because unlike past instances we've had oil supply shocks, inflation was pretty low. Now, it's already high and if inflation's going to keep it higher for longer. The Fed's not going to tolerate that and they're going to raise rates more than what is [inaudible 00:34:29] or baseline forecast.

Mark Zandi:                      So we have four rate hikes, a quarter point each this year. March, in a couple weeks, June, September, December, what's what are the markets now saying, because at some point-

Ryan Sweet:                      Seven.

Mark Zandi:                      ... Russia... Are they still saying seven rate hikes?

Ryan Sweet:                      They went back up to seven.

Mark Zandi:                      Oh, okay.

Ryan Sweet:                      I checked this morning. So they went down below six and then they went back up to seven because I think they're doing the same thing we are. Inflation expectations are going to increase because of the higher oil prices, retail gasoline prices, and then also the CPI is going to remain elevated for the next few months. And that to them is a hint that The Fed's going to go more aggressively.

Mark Zandi:                      So prior to Russia's invasion, the markets investors were starting to price in a half a point increase-

Ryan Sweet:                      Yeah. That's gone.

Mark Zandi:                      ... in the funds right target. That's gone.

Ryan Sweet:                      Yeah. Yeah. I think I checked this yesterday. It was, it was a 100% before Russia invaded Ukraine. Now it's down to zero.

Mark Zandi:                      Zero. Okay. So what's going on, this is my way of framing it, because of the uncertainty created by this event, the thinking is The Fed's not going to go a half a percentage point at the March meeting.

Ryan Sweet:                      Correct.

Mark Zandi:                      They're going to go a quarter point. So the markets now are all in on that, but because all of this means higher oil commodity prices, higher inflation, inflation expectations could come undone, the markets expect still the same seven rating increases, but that would be... What would that be? Would that be one at each meeting? No, there's-

Ryan Sweet:                      It is.

Mark Zandi:                      It's one at each meeting?

Ryan Sweet:                      For the rest of the year. Yes.

Mark Zandi:                      FOMC meeting. Okay. Through the rest of the year.

Ryan Sweet:                      And March is a done deal. So Fed chair, Jerome Powell testified today a semi-annual report to Congress and he said, "We're going to raise interest rates later this month." So all we know 25 basis points [inaudible 00:36:20].

Mark Zandi:                      Okay. All right. We were four before Russia invaded. We are four now. Markets were at seven before Russia invaded. They're at seven now. So we had a different perspective on how aggressive The Fed was going to be, but still do, nothing really has changed here. Fed policy, monetary policy is unchanged as a result of the Russian invasion.

Ryan Sweet:                      Yeah. I think the market's doing some of The Fed's work for them. So that's why it's hard to see them doing seven interest rates. I mean, financial market conditions are tightened a lot. You've seen corporate bond spreads widen out. They're still really low from historical perspective, but they're widening. The stock market, as you said, is down 10%. So if it goes further, that actually takes hikes off the table because the markets are doing some of The Fed's work.

Mark Zandi:                      That's a great point. So the monetary policy affects the real economy largely through, or at least primarily through, initially through financial conditions, stock prices, credit spreads in the bond market, long interest rates generally, that kind of thing. So because the Russian invasion has caused stock prices to fall, caused corporate bond yields to rise, the borrowing costs for businesses to rise more, that has taken some of the pressure off The Fed. So it's almost like that is a rate hike.

Ryan Sweet:                      It is. Right.

Mark Zandi:                      An additional rate hike by The Fed. Okay. All right. That makes a lot of sense. Okay. Very good. Okay. Let me bring in one of our other colleagues at this point, Adam Kamins. Adam, welcome. Adam manages our U.S. Regional Economic Analysis and I asked him to join because I'd like to hear a little bit about what you think this means for different regional economies across the U.S. How's your thinking changed with regard to that?

Adam Kamins:                  Sure. Thanks, Mark. So as everyone sort of suggested and as you suggested when you're talking to Cris, the shock to the U.S. economy is going to be fairly mild, at least in the baseline, but there are some real differential impacts. So the way I think about it is there's energy market impacts and then everything else. So in terms of energy markets, we already touched a little bit upon the fact that oil prices are going to be high across the U.S., across really all major shell plays in the U.S. prices are going to be above break even for a while. So I think we're going to continue to see more investment, more drilling, taking place. So places like Texas, North Dakota, Alaska, Oklahoma, all these places that really depend on the energy economy on oil are positioned to benefit to some extent.

                                             Now, I would caution everyone not to get too optimistic about the prospects for those states. I think there's enough uncertainty around where oil prices are going to go. That I don't know that they're going to invest as if we're going to have a $100 barrel oil for the next six to 12 months per se, and then there's a lot of constraints around costs. Capital costs are high. Labor costs are high. Because of all of that, I think that investments going to be a little bit more restrained than you might otherwise see when oil prices are what they are right now. And then the other kind of positive impact I would say would just be some spill over to the Midwest and portions of the country where oil drilling equipment is being made. Right? So just downstream and upstream impacts throughout the supply chain for energy producers.

                                             I think you do get a benefit there. So that's the upside. The downside is much more diffuse. We can't identify a handful of states the way we do with oil producers and say, "These are the states that are going to be hurt significantly more than others," but there are some ways to differentiate. So I think the most important one is looking at the consumer picture and where rising gasoline prices are going to hurt most. So the first thing we look at, whenever there's an oil price shock in either direction is where do people drive the most, right? And where do they use the most gasoline? So actually I could quiz everyone here. I know we don't have time for quite a numbers game here, but...

Mark Zandi:                      It's not appropriate, but my guess is low income households in the Southeast is where you'd see the biggest impact because that's where folks drive the most. Is that right?

Adam Kamins:                  Exactly. So I was going to ask which state. Yeah, exactly. So I was looking at which state?

Mark Zandi:                      South Carolina, Georgia, North Carolina?

Adam Kamins:                  You're in the ballpark. Yeah. It's Alabama. Alabama, Mississippi, the Dakotas, those are the states where there is the most gasoline consumption per capita. That reflects the fact that people drive more. Also reflects the fact that EV and hybrid penetration is lower. People are driving larger vehicles in those regions. So the impact of higher gasoline prices is just going to be more pronounced and the impact on consumers is going to be more pronounced in those areas. And then firms that rely on energy as an input are also going to be hurt, right? So automakers are going to be hurt, not so much because they are relying on energy as and input, but just because the broader impact to gasoline prices.

                                             And then there are a handful of other energy intensive industries. The paper production, cardboard production industry actually is one that's been doing quite well since the pandemic with more packaging being produced. That one takes a major hit. That is among the most energy intensive industries out there. So any area that depends on that will also face a little bit of a setback. I can stop there. That's kind of the energy picture. I don't know if you want me to dive into some of the other impacts as well, or if we want to pause here for a second.

Mark Zandi:                      Well, Gaurav mentioned some localized impacts on real estate markets because of particularly Russian investment in those markets. Do you have any examples of that here in the U.S.?

Adam Kamins:                  Yes. So there's two markets that I think are most concerning. That would be New York City and Miami. Those are markets that probably not to the same extent as London or in Western Europe, but those are the two markets in the U.S. that do have a bit of exposure to Russian investments. So just to give some context, one specific Russian oligarch Abramovich, I believe is his name, has, I think it's over 100 million in properties in Midtown Manhattan, right? Generally, these oligarchs have not been sanctioned directly, but certainly, the ultra-luxury market in both of those cities demand is very limited. There's only a handful of people that can afford these really high end departments and Russian oligarchs are generally them and a number of wealthy Chinese investors.

                                             So you're losing part of the demand pie there. The one thing I'll say about all of this is that a lot of these very wealthy Russian individuals who are buying properties in these markets, it's not as if they're closing, signing their name and it's just attributed to them directly. There's shadow corporations. There are other entities at play here that I don't think it's a straight line from sanctions to suddenly these Russian buyers are just totally out of the picture.

Mark Zandi:                      Okay. Very good. And in terms of trade between the U.S. and Russia, what are some of the major things that the U.S. exports to Russia and do they have any regional consequences?

Adam Kamins:                  A little bit. So transportation equipment is the biggest one. So the two states that have the most exposure to Russia as a destination for exports are South Carolina and Washington, right? So South Carolina is motor vehicle parts and cars generally. Washington, it's about aerospace right? Aerospace equipment going to Russia. Both of those are going to grind to, I think, maybe not grind to a complete halt, but pretty close with the sanctions regime and possibly some self-sanctioning as well.

Mark Zandi:                      Is that a big deal in the grand scheme?

Adam Kamins:                  Yeah. I was going to say it's not that big a deal though.

Mark Zandi:                      Oh, okay.

Adam Kamins:                  So just to put it in context, so South Carolina is the state that over the last few years has the highest exposure to Russia as an export market. It is the 20th highest... In terms of the countries that South Carolina sends its products to, Russia rank 20th on the list. It's less than 1%. So it's not really going to have a material impact on the economy there.

Mark Zandi:                      As I mentioned earlier, one other question I get is, "Well, if the European economy struggles as a result of this, then what does it mean for U.S. trade? So are there regions of the country that are more exposed to Europe? I mean, I would assume the Northeast, if my recollection is correct. Is that right? That was it?

Adam Kamins:                  Yeah. That's right. Generally, the Northeast is the most exposed to the European economy, partly through trade and then partly just through the flow of people back and forth, but travel back and forth to Europe. I don't think... Russia, obviously Ukraine are not big markets in terms of attracting visitors to big Northeastern cities, but if the rest of Europe is severely disrupted and suddenly the flow of tourists from London or Paris or Italy or wherever, Germany, if that slows materially, then that has a very significant impact on the Northeast. But that's a risk. I don't expect that to happen.

Mark Zandi:                      Yeah. Okay. Any other links that we're not thinking about or I'm not thinking about in terms of the U.S. and in Russia that has a differential regional impact?

Adam Kamins:                  I'll give you a couple. Just quick hitters here. So one would be farms and farmers, right? So we talked a lot about wheat prices already. There's a lot of volatility there. There could be upside associated with wheat prices, but Russia is a big exporter of fertilizer. So that is going to push farmers' costs up. All of this means consumer prices for food are going to go up, but there's, I think, even more uncertainty for farmers, which unfortunately for them, is kind of par for the course when there's big geopolitical events. We saw this with the trade war a few years ago, but I think just more risk in both directions for farmers.

                                             And then the other one that I would highlight, and this actually is a follow up to something that you talked about in the podcast last week would be neon exports from Russia and the impact on semiconductors, right? So that could have a significant impact on the Western U.S., in particular, Silicon valley, Portland, Phoenix, Boise. These are all places that have a very large semiconductor manufacturing presence. There's been a lot of talk, actually. I think at the state of the union, this came up. The new Intel plant in Columbus, a lot of excitement around the possibility of domestic semiconductor manufacturing, rightfully so, but this could be very disruptive to that and some of the upside there might take a hit.

Mark Zandi:                      Great. Well, thanks, Adam. That was a really good swing around the country. So let me now turn to another colleague, Alfredo Coutino. Alfredo manages our LatAm team and Alfredo, I haven't really thought about LatAm that carefully, but it feels like there's a lot of crosswinds here that higher commodity prices is probably a good thing for a lot of the LatAm economies, but yet LatAm is tied into China and the rest of the emerging world and in terms of growth, that can't be a good thing, but what is the net of all that? Is this good or bad for LatAm?

Alfredo Coutino:              So far is good and actually, I would say that unlike other external shocks in the past, we could see that there are some benefits for Latin America so far. I'm talking about in the past two months and particularly in the last week, basically because first of all, the region doesn't have strong financial links with Russia, with Ukraine. A little more with Europe, particularly with Spain, U.K., Germany, but financial markets have not been impacted significantly in the past few days and actually what we see is that it was only a small overshooting in currencies. That was last Thursday when things were more uncertain between Ukraine and the rest of the world, but then Latin American currencies appreciated. So in net, I would say that in the past two weeks, Latin American currencies have not depreciated, but on contrary, they have reevaluated.

                                             Now, one important factor behind this is the high commodity prices. As you mentioned, it's a positive for Latin America. So governments are getting extra export revenues. Central banks are accumulating more foreign reserves, and that explains, to a great extent, why Latin American currencies are behaving positively, but of course, it's just a week since the military conflict started. So it's too early to say, "So what is going to be the impact on the real economy?" But so far, I mean, experts in Latin America have been performing very well, not only this year, but since the second half of last year, and I would say a common denominator for most of the countries in Latin America, if there is a negative impact in coming months, it's going to be minimum and the government is getting extra revenues to offset or counter any potential inflation impact on consumer prices. So that's what we are seeing now in Latin America.

Mark Zandi:                      Okay, great. The economic jargon would be the terms of trade have shifted in favor of LatAm economies just because prices are up for the things that they produce, for the commodities they produce.

Alfredo Coutino:              Yeah, right. Yeah, yeah, absolutely.

Mark Zandi:                      And so far, the growth effects are minimal. Doesn't feel like that's going to be a big deal. So the price effects are a plus here.

Alfredo Coutino:              Yeah. And actually there is a side effect which could also benefit Latin American exports. And that happens two years ago when it was an aggravation of the trade frictions between the U.S. and China. So the U.S. turned to Latin America producers of agricultural products, and it started to import from Latin America. So something similar could happen here also, particularly because Russia is a big producer of agricultural products. So Latin America could gain some market share in this particular [crosstalk 00:51:56].

Mark Zandi:                      Yeah. A way of thinking about it is Russia is like an emerging economy really, when you think about it. So what happened is Russia is no longer really a player and these markets are much less of one, or there's the fear that they will be, and therefore, that's driven up the price. So it's benefiting other producers of these commodities and that's LatAm economies.

Alfredo Coutino:              Absolutely. Yes. Yeah.

Mark Zandi:                      Okay. Okay. Okay. Very good. Well, thanks for that. We're going around the world here. Finally, I want to land with Steve Cochrane. Steve manages our efforts in Asia and Steve, emerging markets here, it feels more like a small negative. I don't think it's a positive because Asia consumes a lot of energy in these commodities. Doesn't produce a lot of them. So the terms of trade have shifted away from Asia, but the impact here feels small. Is that a fair characterization?

Steve Cochrane:              I think that that is fair. I don't think we'll see the impact here that we see in Europe, but it's not the plus that Alfredo was talking about in Latin America. You know that the channels by which the Ukraine war impact Asia are through energy. There are four basic channels in ordered. The biggest one of course is energy because all of Asia with the exception of Malaysia is a net energy importer. And then food prices will be very, very important in terms of what happens with inflation. The third is supply chains, much like what Adam talked about with the U.S. [inaudible 00:53:47]. And the fourth, but maybe less so is financial volatility. But with energy, this is a very important aspect of the economy because the economy has been doing very well and much like Latin America, the exports have been strong over or the last year, And the fourth quarter was very strong in Asia.

                                             Even into this January, February, industrial production has been very strong and exports have continued to be strong, but that advantage may begin to disappear if demand from Europe in particular begins to up at the same time that cost of energy begin to rise. There's not a lot of direct deliveries of energy, crude oil petroleum from Russia to Asia. It's all indirect. So it's really just the indirect price effects with two exceptions. China and India do buy a fair amount of crude oil, petroleum, and coal directly from Russia. So if those supplies are cut off in any way, that would actually be to the detriment of China and India.

                                             I mentioned food second because food inflation has been very critical in Asia that where inflation has been high to a high degree, it is because food prices have been high and energy plays into the cost of production and distribution of food. And this, again, India seems to come up a lot. I think if there's one single country that is probably at the highest risk, it is India. And because one, it has the highest inflation rate now in all of the major Asian countries. It's at 6% and it actually went up last month to 6%. And much of that is because of food and there is some exposure to imports from Ukraine in particular in India. There's been a shortage for a while of edible oils, cooking oil in India and a lot of that has been lately provided by Ukraine. They provide sunflower oil and such, and that may be gone and they will need to look for other sources of that. And that could add to food inflation. It could then tick up total inflation up.

                                             Right now, it's right at the very top of the Reserve Bank of India's inflation target rate, which is between four and 6%. And the RBI has been holding back on raising interest rates, trying to give the Indian economy a chance to get back on both feet. And they're going to have some tough decisions to make very soon about policy normalization and I think policy, and going to Ryan's point about The Federal Reserve, one of the risks in Asia is that our baseline forecast is that except for a few countries where inflation now does exceed target rates like in Korea, Singapore, and New Zealand, that central banks would give the economies another six months or so at least to really show that they're back on their feed after COVID last year, before they begin to normalized rates. The risk is that if The Fed were to say hike by 50 basis points, then central banks in Asia might have to move sooner.

                                             It sounds like that risk is easing a little bit and that's a good thing. Finally, to go back to supply chains, Korea, Taiwan, very critical providers of semi-conductors and Malaysia and Thailand, components for those semiconductors. It seems like the semiconductor makers in the region do have at least a near term supply for all these rare gases and rare minerals that go into chips, but if this lasts a long time, these supply chain shortages could ramp up once again. Right now, it feels like supply chains in Asia are really beginning to ease up. Things aren't nearly as bad as they were back in the, say the third quarter or fourth quarter of last year. So we're okay in the near term, but if these supply constraints continue for some time, then we're back to square one on the supply chain issue for tech.

Mark Zandi:                      Thanks for that, Steve. Quickly, U.S.-China relationship, obviously quite tense. Any discussion in Asia around what all this means for that relationship or anything?

Steve Cochrane:              There are a lot of discussions. You see, there are a lot of conversations going on, maybe is the best way to say, of just trying to figure out where Asia fits between China and the U.S. now. For much of a Asia, there's a very natural fit with China in terms of their very strong trade links and such. And also the fact that the U.S. had stepped away from Asia for some time. So the question really is well, so is the U.S. really going to step back into Asia and Southeast Asia and take a firm role and actually encourage a more U.S. investment in the region and such and offset China?

                                             And then of course, the conversation about China and Taiwan is always part of the conversation as well of what are the security risks? How heightened are the geopolitical risks in the region? There's a little bit of uncertainty. There's also some positive feeling that as geopolitical risk becomes increasingly an important aspect of the whole risk appetite of firms and so forth, that this could accelerate investment away from where investment is now concentrated to a certain extent, China, of course, Vietnam as, as well, and a spread out across particularly Southeast or India. So the risks, the conversations go in both directions, but certainly, there's lots and lots of talk going on.

Mark Zandi:                      Okay. Very good. Okay. We covered a lot of ground. Guys, anything I missed that I should have brought up in the conversation? Any other points? No? Okay. All right. Well, very good. Obviously, this is the second podcast we've done, I think, in the last two weeks on Russia-Ukraine, and there'll be more. We have a webinar next week where we will reprise this conversation, but we'll have some more graphics and more in-depth discussion, and we will continue to bring you any changes that we make to our thinking about the economic outlook. So with that, let me call it a podcast and thanks very much for attending. Take care.