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by  Eric Lascelles Mar 15, 2022

What's in this article:


We released our latest economic webcast on March 1 (and thus now slightly stale in its assessment of the war in Ukraine, but otherwise informative). See Geopolitics weigh anew on the outlook.


This week’s note furnishes further thinking on the Russia-Ukraine war. We also revisit the pandemic and examine the latest economic and central banking trends and ideas.

Alas, the news remains mostly negative:

  • The war in Ukraine continues.
  • We have downgraded our European growth forecast and upgraded the inflation outlook.
  • COVID-19 cases are surging in China – potentially to the detriment of factory output. Cases are also rising again in parts of Europe.
  • The recession risk has increased.

Fortunately, it isn’t quite all bad news:

  • Commodity prices have retreated from highs in recent days.
  • Economic growth remains more likely than recession.
  • The diminished growth outlook could be for the best as it reduces the risk of overheating.

War in Ukraine

The war itself

Russia’s attack on Ukraine grinds on. Russia has suffered considerable losses and advanced only slowly, while nevertheless inflicting enormous damage on Ukraine. The human tragedy continues.

The war could still resolve in a number of different directions. At its essence, the debate is centred on two scenarios:

  • Is it the Russian goal to create a buffer of allied and dependent states along its border as it sought and secured when it invaded parts of Georgia in 2008 (and as it may today seek in the form of Ukraine’s eastern provinces)?
  • Or, is the situation instead akin to Russia’s 1994 invasion of Chechnya? Here Russia captured and then absorbed the whole of a country that had declared independence several years earlier when the Soviet Union fell.

If the goal is the former and Russia’s broad attack has simply been to make Ukraine and the West more willing to cede the eastern provinces in a peace deal, then a cease-fire could be reached fairly quickly. Indeed, the tone of reporting around negotiations gives the impression that there is the real chance of a deal being struck. Russia is no longer demanding regime change in Ukraine. A Ukrainian negotiator has said “Russia is already beginning to talk constructively.” Russian President Putin has also indicated there have been “positive shifts” in the talks.

Certainly, if this is the case, both countries are well incented to strike a deal: Ukrainian lives and infrastructure are being destroyed, while Russia now faces economic destruction. This possibility likely explains why commodity prices have recently unwound a portion of their prior extraordinary gains.

But if the Russian goal is instead the latter – a complete takeover – then the war could be drawn out. The name of the game so far has undeniably been escalation. For context, the war in Chechnya lasted 20 months. Were Russia to successfully occupy most of Ukraine, civilian resistance would likely be substantial, dragging out the conflict. Although the analogy is not perfect, Russia struggled to maintain control of Afghanistan for a full decade before finally abandoning the country.

The worst-case scenario from a military perspective now seems unlikely: Russia hardly seems in a position to broaden its offensive to other countries once part of the Soviet bloc or Russian empire given how hard it is having to work to capture Ukraine. Further, NATO is now strengthening its positioning.

However, the worst-case scenario from an economic perspective cannot be fully ruled out: it remains possible that the Russian supply of energy could be completely interrupted.

Economic sanctions

Economic sanctions continue to mount. In late February, western nations largely halted exports to Russia and blocked financial transactions. The U.S. and Canada have since announced a ban on the importation of Russian oil.

The other key development over the past few weeks has been the mass exodus of western corporations from Russia. There are few that continue to operate. The list of departures includes Shell, BP, McDonald’s, Sony, Nintendo, Disney, Nike, Volkswagen, Apple, Samsung, FedEx, UPS, Visa, Mastercard, American Express and a wide array of banks.

In several instances, the dockworkers at western ports are also refusing to unload Russian cargos.

Russia is now striking back with its own economic sanctions. It will no longer export certain products to countries it deems “unfriendly states.” The ban applies to the export of telecom, medical, agricultural, vehicular and electrical equipment, plus some forestry products. The agricultural aspect of this could bite particularly hard.

China is far from joining western nations and has continued to buy energy and agricultural products from Russia. However, it has distanced itself somewhat from Russia in recent weeks, and is complying with western financial sanctions.

High oil prices

Oil prices remain quite high, though they have actually declined somewhat from their peaks a few weeks ago (see next chart). This appears to be in part because a widespread ban on Russian oil exports has so far been avoided, and in part because there is the possibility of a ceasefire.

Oil prices surge on robust demand recovery, Russian invasion

Oil prices surge on robust demand recovery, Russian invasion

As of 03/14/2022. Source: Bloomberg, Haver Analytics, RBC GAM

At stake are the roughly 5 million barrels of oil Russia exports each day. As already indicated, some countries have now officially banned the importation of Russian oil. Russian oil now trades at a discount of $20 to the global price, meaning that other parties are not keen for Russian oil either. Some countries that continue to import the oil are asking that Russia transport the oil to their shores as many international shipping lines are now unwilling to do so. Russia’s capacity to produce oil has also been hurt by the withdrawal of foreign capital and the exit of major foreign producers.

The bulk of the decline in Russian supplies appears to be coming from the demand side of the equation so far. However, it cannot be completely ruled out that Russia might voluntarily cut its exports. While this might seem counterproductive from a financial standpoint, that isn’t necessarily the case, at least in the short run.

To the extent that a 1 million barrel per day mismatch between the supply and demand for oil is worth around $29 per barrel, if Russia were to voluntarily cut its exports by 3 million barrels per day, all else equal, it would increase oil prices by nearly $90. This would almost double the price of oil while reducing Russian production by less than a third (10 million barrels to 7 million barrels). In this scenario, Russia would earn greater revenues and profits producing 7 million barrels per day than it currently does producing a larger amount.

It bears mentioning that, in the long run, this strategy would then backfire as the rest of the world would scramble to find new supplies and adjust its demand downward, eventually rendering the idled Russian production surplus and resulting in a lower global equilibrium price for oil.

To the extent that Russian oil is less desired, if not strictly unavailable, to what extent can we expect adjustments in demand and supply to restore balance to the oil market?

Demand adjustment

High energy prices, of course, decrease demand all by themselves via conservation efforts and demand destruction in the economy. The former is desirable from an environmental standpoint, but we want the latter to be minimized for the sake of the economy.

Some countries seem capable of absorbing more of the unwanted Russian oil. China is the most obvious such nation, but India may also be able to do so. For that matter, there were 35 countries that abstained and 5 that voted against the UN effort to condemn Russia’s invasion. Those might be thought of as Russia’s allies, and are best positioned to buy more Russian products as others spurn them. Of course, this rerouting cannot happen instantaneously.

Supply adjustment

Several countries have begun the process of releasing oil from their strategic reserves, with the theoretical potential to unleash 1.5 billion barrels (300 days of Russian exports). Unfortunately, inventory levels are lower than usual, or this capacity would be even greater (see next chart).

Global crude inventory levels have fallen below historical average

Global crude inventory levels have fallen below historical average

As of Feb 2022. Global oil inventory reflects OECD commercial crude stock and consumption. Historical average since 1997. Source: EIA, RBC GAM

The supply of oil naturally increases when the price goes up. U.S. shale oil is well positioned to participate for two reasons:

  1. It is the most nimble producer – able to increase production with the least lead time.
  2. The decline rate for shale oil production is quite high, meaning that wells dry up extremely quickly. That’s normally a headache, but it is actually a feature right now because the demand for non-Russian oil may only be temporarily higher. Other producers have to be confident that demand will be elevated for years, whereas shale can take advantage of shorter windows of high oil prices.

That said, shale oil producers insist they won’t respond too enthusiastically to the increase in oil prices. Many were burned by the prior oil bust, which resulted in widespread industry suffering. Managers insist they will remain disciplined, focusing on paying dividends and not over-expanding. Estimates vary between shale oil production rising by just a few hundred thousand additional barrels per day to 1.4 million more barrels per day – but not millions upon millions.

Meanwhile, OPEC producers are theoretically capable of producing more. If quotas were lifted and all produced to their absolute limits, they might find an extra 3 million barrels per day of output. More realistically (though likely also a stretch), OPEC producers are actually producing around 1 million barrels per day below their quotas right now. The problem is that OPEC cannot be seen to be acquiescing to U.S. demands: Russia is an OPEC partner and a significant military ally for many.

On the other hand, OPEC does not actually want extremely high oil prices, as that encourages more shale oil production, fuel conservation and the development of additional green technologies which hurt the cartel in the long run. To the extent there is scope for more OPEC oil production – and the U.S. is hard at work trying to encourage such an outcome – the most obvious candidates are, improbably, Venezuela and Iran. While neither is especially inclined to help the West, both would like an easing of the sanctions that currently hobble them. Iran is thought capable of providing an additional 1 million barrels per day were sanctions to ease.

Net effect

There can be little precision when trying to gauge just how much different parties will increase or decrease their supply and demand. The net change in the supply-demand balance could be anywhere from a shortage of 0 to 5 million barrels per day to 5 million barrels per day. We budget for a 2-million barrel per day mismatch. To the extent that each million barrels theoretically increases the price of oil by $29, that argues for an oil price of around $143 as the mismatch is resolved.

But, again, there are scenarios in which oil prices settle back to $85 if Russian exports are not significantly impeded, or alternately that oil prices surge well past $200 if the entirety of Russian exports is blocked. Right now, oil prices are somewhat lower than the base-case level assumed in this analysis. It is arguably the case that the risk of a major disruption is falling given that all parties have failed to act forcefully despite several weeks of opportunities.

High natural gas prices

Natural gas prices have also soared due to concerns about Russian supply (see next chart). Unfairly, this has received less attention from economists, likely because there is a long history of oil shocks and their economic impacts, whereas there is relatively little off-the-shelf information about what happens to economies during natural gas shocks. Helping to explain why that is, the natural gas market is inherently a messier market. It is much more regional such that natural gas prices can vary widely between countries. In addition, governments tend to smooth out sharp movements in the cost of natural gas for end consumers.

Germany NCGI Natural Gas Index

Germany NCGI Natural Gas Index

As of 03/11/2022. Source: Intercontinental Exchange (ICE), RBC GAM, Macrobond

In the present instance, it also happens to be the case that natural gas prices had already increased sharply before the pandemic – by a factor of around five over the prior year. On top of that, natural gas prices have increased by a further 50% this year (and that +50% looks especially big when taken on top of the giant earlier leap). It has already been established that natural gas prices can rise sharply without automatically inducing a recession – it just happened!

Europe is naturally the most vulnerable to the possibility of a Russian natural gas outage. For the moment, Russia has pledged to continue meeting its contractual obligations (and it certainly needs the money). At the same time, Europe has continued to import as much as it is allowed to import.

However, Europe aspires to reduce its reliance on Russia. Its new RePowerEU plan proposes to reduce Russian natural gas imports into the European Union by a factor of two-thirds by the end of this year. It isn’t entirely clear that this will be genuinely possible. It requires the simultaneous stockpiling of inventories, sourcing new natural gas via pipelines and liquid natural gas terminals, relying more on domestic coal and nuclear power, making a green energy push, and pursuing various energy efficient policies. For its part, the U.K. proposes to eliminate its reliance on Russian natural gas altogether by the end of the year.

In the near term, the reliance on Russian natural gas should fall for seasonal reasons as the weather warms. The real test – should the war and/or sanctions persist until then – will be next winter.

High food prices

The impact of the war on the supply of food may have less of a direct impact on global economic growth than the supply of energy, but unquestionably has a bigger impact on human lives.

Russia is banning the export of many food products, and Ukraine has also now blocked wheat exports. The logic for Russia is in part punitive, but for both it is in significant part because the countries fear being cut off from foreign food supplies and so seek to maintain a sufficient domestic inventory.

Ukraine cannot easily harvest or plant crops during the war, the country’s main port is now under siege, and the Black Sea is no longer a friendly place for ships transporting crops from either of the two countries. Ship insurance is reportedly no longer available for such voyages.

Russia and Ukraine are the largest and fifth largest wheat exporters in world. Together they represent 29% of global exports of the product. Paired with poor harvests over the past year, inventories are 31% below normal today. The Economist magazine reports that the two countries collectively provide 12% of the calories exported worldwide.1

The Financial Times estimates that if the war does not soon end, the global supply of major agrarian products will fall by 10% to 50%. These products include wheat, barley, corn, rapeseed and sunflower oil.2

These agricultural products are consumed disproportionately by Turkey, North Africa and the Middle East. But to the extent that the commodities are part of a global market, the real pain will come in the form of higher prices and be inflicted on those with the lowest incomes, wherever they are in the world. Rabobank estimates that the share of income dedicated to food purchases will have to rise from just over 20% in Sub-Saharan Africa to well over 30%. The increases are significant if less extreme for South Asia, Latin America and the Middle East & North Africa.

The food consequences may spill over into next season. Russia and ally Belarus are major fertilizer producers, and the second and third largest producers of potash in the world (Canada is first). Exports of fertilizers are also being blocked. This limits the ability for the rest of the world to compensate by planting additional crops or increasing farm yield. To compound matters, fertilizer prices were already two to three times higher than normal before the onset of the war. Ukraine, in particular, is unlikely to be able to plant a normal crop for the summer ahead.

Lastly, it must not be forgotten that the last time food prices soared globally, widespread protests resulted, disproportionately in North Africa, with the result that governments toppled. Additional geopolitical problems could spiral from the Russian war.

Other commodities

Sanctions also create various pinch points for manufacturing.

Half of the world’s neon production – sourced from Ukraine – has been halted by the war, potentially exacerbating the global shortage of computer chips.

Nickle prices have soared on supply concerns – the material is an important component of batteries.

Palladium prices have also skyrocketed because Russia normally produces around 40% of the world’s supply. Palladium is used in catalytic converters (for internal combustion engines), among other uses.

Russia is also a major producer of other metals, including aluminum, steel and copper.

Economic implications

We wrote at length about the Russia—Ukraine conflict in our last #MacroMemo, including our first-blush economic estimates. The damage is set to be very real.

What has changed since then? We’ve gained a little more clarity and insight, though precision remains lacking. Let us run through the new developments.

Largely reflecting wider credit spreads and weaker stock markets, financial conditions have tightened considerably (see next chart). This exerts a drag on economic growth.

Global financial conditions tightening quickly

Global financial conditions tightening quickly

As of 03/10/2022. Source: Goldman Sachs, Bloomberg, RBC GAM

Naturally, we begin with Ukraine, which is damaged by the presence of the war itself. It is hard to fathom there is much economic activity occurring in the beleaguered country. The Ukrainian central bank has now weighed in, estimating that the level of gross domestic product (GDP) is down by half. It seems likely to us that the level of output has fallen even further.

Russia is primarily damaged by sanctions. A survey of Russian economists reveals an expected 8% decline in economic activity in 2022. This is in line with our own thinking, which is that the decline is likely somewhere in the realm of -5% to -15%. The survey also predicts that Russian inflation will rise to a lofty +20%.

For the rest of the world, we now expect a subtraction from global growth of around -0.5%. That puts global growth in the middle of the 3% to 4% range for 2022.

Clearly, the biggest economic hit outside of the immediate orbit of the war is to the Eurozone. Two weeks ago, we had flagged a drop in expected growth from the high 3% range to just under 3%. With the caveat that these are just working numbers and so subject to further revision, we now look for merely +2.5%. It is tempting to be even more pessimistic about the European growth outlook. However, commodity prices have recently retreated and it is notable that the European Central Bank has only cut its growth forecast by half a percentage point. That leaves 2022 at a still lofty +3.7%. It is just as possible that our forecast is too pessimistic as that it is too optimistic.

As a general rule, the countries that are the greatest net importers of energy are the ones set to experience the greatest deceleration. That would suggest, in addition to Europe, that many Asian nations could also be adversely affected.

In contrast, commodity-rich regions such as South America and North America should fare somewhat less poorly. The U.S. is now not just a net energy exporter but a net oil exporter as well, providing it with helpful offsets. Canada is particularly well buffered by having a very similar commodity mix to Russia. The two countries both now appear capable of around +3.1% growth over 2022 – less than imagined a few months ago, but still solid growth. For that matter, 2.5% Eurozone growth is still technically consistent with an economic recovery. It is, however, a much less enthusiastic one than previously hoped for.

Inflation implications

Two weeks ago, we figured the U.S. Consumer Price Index (CPI) would peak at around 8.5% year-over-year (YoY). This was above our prior forecast for a +7.5% peak. Now, it seems likely that inflation could peak even higher, at as much as +9.5% YoY. This puts inflation within grasp of a double-digit reading, which could bring negative psychological effects. Then again, commodity prices have recently retreated somewhat, tempering that risk.

In the Eurozone, we now look for a peak inflation rate of around +8% YoY. This is also a few percentage points above the previously forecast peak.

Longer-term thoughts

We wrote two weeks ago about long-term themes including the revival of the Cold War, a potentially strengthened Russia-China partnership, a renewed NATO, shifting European energy dynamics and the risk of nuclear proliferation.

This week, we add four further thoughts.

  1. As referenced earlier, there is the likelihood of greater political turmoil in poor countries as they grapple with high food (and energy) prices.
  1. Europe and North America may manage to reduce their reliance on Russian energy. However, this will likely be accomplished, at least in part, by claiming a larger fraction of the energy supplied by non-Russian producers. That means, by extension, that other countries will suddenly find themselves without their usual non-Russian energy supplier, forcing many into the arms of Russia. Russia’s sway over these other, likely poorer countries, will presumably increase even as it declines over Europe and the West.
  1. Supply chains are further incented to become more robust and to be aligned across like-minded nations. Some of this was already happening in recent years in the manufacturing sector. Countries sought to make their supply chains less reliant on potential geopolitical foe China and to make their supply chains less fragile in light of the stop-and-go pandemic experience. Now, it would appear that similar changes will be sought for raw material supply chains.
  1. Ukrainian refugees could have a significant effect on the rest of Europe. Already, more than 2.5 million people have fled Ukraine, and the number seems likely to continue rising significantly. Some will return when the war is over (especially since most men remain in Ukraine). However, many will not, either because of the destruction to Ukraine or the economic opportunities that wealthier European nations provide. The European Union population could well grow by 1-2% in short order. Such migrations are not friction free, as was demonstrated in 2014—2015 when many refugees arrived in Europe from the Middle East and Africa. But, as the migrant population settles and gains employment, there is the opportunity for materially faster Eurozone economic growth over the period of several years.

Pandemic revival

It has now been exactly two years since the pandemic and resulting lockdowns ground the world’s economy to a halt in the spring of 2020. The situation is far better today. Financial markets haven’t paid much attention in a while, but it cannot be said that the pandemic is completely over.

In fact, COVID-19 has only now become infectious enough – via the Omicron variant and now the BA.2 sub-variant – to begin overwhelming parts of Asia that had managed to limit or entirely dodge prior waves of the pandemic. Mainland China is front and centre, with a skyrocketing number of infections (see next chart). The absolute numbers are not high, but the exponential rate of growth is familiar to people in other countries.

China, daily new confirmed cases

China, daily new confirmed cases

As of 03/13/2022. Source: Our World in Data, Macrobond, RBC GAM

Perhaps China will manage to deliver sufficiently aggressive lockdowns to mute the virus again, but it seems more likely that the virus will continue to circulate despite their best efforts. China continues to make every effort to limit the virus, most recently locking down the massive city of Shenzhen, the entire north-eastern province of Jilin, and imposing stricter rules on Shanghai.

Meanwhile Hong Kong has experienced an uncontrolled surge of infections, compounded by a low vaccination rate among the elderly. All of this, of course, increases the potential for a significant economic drag emanating from the Chinese economy.

Elsewhere in Asia, cases are also surging in South Korea (long a success story – see next chart), Malaysia, Singapore, Thailand and Vietnam.

COVID-19 cases and deaths in South Korea

COVID-19 cases and deaths in South Korea

As of 03/14/2022. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM

Some developed world countries are also beginning to report rising numbers of infections as well (see next chart). The list includes Switzerland, Germany, the Netherlands, and possibly Italy and the U.K.

COVID-19 emerging markets vs. developed markets infections

COVID-19 emerging markets vs. developed markets infections

As of 03/14/2022. Calculated as the 7-day moving average of daily infections. Source: WHO, Macrobond, RBC GAM

In Canada, the number of infections is not rising, but neither can it be said to be falling anymore with much enthusiasm (see next chart).

COVID-19 cases and deaths in Canada

COVID-19 cases and deaths in Canada

As of 03/14/2022. 7-day moving average of daily new cases and new deaths. Source: WHO, Macrobond, RBC GAM

Unlike the Asian countries that are simply beginning to grapple with the most contagious new variant, it seems more likely that the increase in infections elsewhere is the result of an easing of pandemic restrictions.

While it appears that pandemic waves will continue to ebb and flow for the foreseeable future – especially if mutations continue to occur – the coming spring and summer in the Northern Hemisphere should provide a period of relative respite.

Beyond that, even if infections rise into the fall and winter, we would bet that most countries will not be willing to impose as many restrictions unless the virus turns in a significantly more deadly or vaccine-resistant direction.

Monetary tightening begins

The U.S. Federal Reserve is on the cusp of raising its policy rate by 25 basis points (bps). It’s the first hike in several years, and the start of a new tightening cycle. We imagine several hikes may occur in relatively quick succession, bringing the policy rate to the realm of 1%, at which point the central bank may take a moment to survey the economic impact while initiating its bond-selling operations.

The Bank of Canada (BoC) has already begun down a similar path, raising its overnight rate by 25bps in early March. The BoC noted that the economy was advancing better than expected and that inflation was similarly higher than expected – both motivations for higher interest rates.

We remain of the view that central banks may materially slow their rate of tightening over the second half of 2022 as they are confronted by decelerating growth and declining inflation.

Economic developments

Strong recent data

The recent trend in economic data has been exceedingly strong. The U.S. created 678,000 net new jobs in February, easily exceeding expectations. The Institute for Supply Management (ISM) Manufacturing Index managed to rise during the month. Retail sales leapt 3.8% higher in January.

In Canada, the February employment print was a jaw-dropping +337,000. This takes the unemployment rate below the pre-pandemic rate, approaching historic lows. Real-time consumer spending data in Canada has been surging since mid-January. In addition, a real-time measure of business activity is also now reviving after an Omicron-induced lull.

Globally, diners are capitalizing on lighter restrictions with a sharp increase in restaurant reservations nearly everywhere (see next chart).

Restaurant reservations

Restaurant reservations

As of 03/02/2022. 7-day moving average of % change vs. 2019. Seated diners from online and phone reservations, plus walk-ins, based on a sample of restaurants on OpenTable. Source: OpenTable, RBC GAM

Higher recession risk

Of course, those happy economic trends largely predate the war in Ukraine, and its impact on commodity prices, financial conditions and sentiment. As such, the risk of recession is rising. We had argued before the war that the risk in the developed world was in the realm of 25% – a function of declining economic buoyancy, a new monetary tightening cycle, less fiscal support, slower Chinese growth, the frictions associated with high inflation plus considerable geopolitical risk.  This risk now appears to be somewhat higher: call it greater than 25%, but below 50%. Europe is toward the higher end of this range, while the likes of the U.S. and Canada are toward the lower end.

Fortunately, this still means that a recession is far from automatic:

  • Normally, recessions come from obvious excesses: in the banking sector, in inventories, in the housing market, in consumer finances, and so on. But, for the most part, these don’t appear to be especially stretched, nor beginning to list.
  • Our recession models continue to point to a recession risk of no more than 10%.
  • Our business cycle scorecard indicates it is still only “mid cycle”, not “end of cycle”.
  • More fiscal support appears forthcoming, even as monetary support is starting to fade (more on that later).
  • Central banks have the option of tightening by less if the economy really begins to wobble.
  • The prospect of a deceleration in economic growth may well allow the economy to expand for longer, as opposed to bringing it to a premature conclusion (more on that as well later).
  • The world is less vulnerable to rising energy prices than in the past. The energy intensity of the global economy is 57% lower than in 1973, and for that matter oil prices have not even doubled this time, versus tripling in 1973. Price controls also appear likely to be avoided this time. The resulting distortions in the 1970s did more damage to the economy than they avoided. Workers are also much better positioned to work from home today if the daily commute becomes unaffordable.
  • A back-of-the-envelope calculation finds that to pay for more expensive oil, U.S. consumers might have to redirect up to 1.5% of GDP away from other spending. While that is significant, it means that when other companies worry about their products being crowded out of the consumer wallet, this should be to the tune of less than 2% – not 20%. Furthermore, the thought exercise, while useful, is flawed: in roughly energy-neutral U.S., other parties are selling oil and profiting by an extra 1.5% of GDP.
  • Rising interest rates present their own challenge, especially given that the expected hikes are in response to high inflation rather than growth. Yet most countries are not quite as rate sensitive as imagined. It is government debt that has mostly increased rather than private debt. Government spending isn’t very interest rate sensitive.

More fiscal support

Central banks are poorly positioned to help the global economy face this war shock: policy rates are already quite low and balance sheets are already large.

As a result, fiscal policy may prove more active over the coming year, providing a lift to growth. This is most true in Europe, where the negative shock is strongest. It’s also where fiscal deficits and public debt are relatively smaller than in the U.S.

This spending may come in a variety of forms. In the short run, energy costs are likely to be subsidized, implicitly as electricity rates and retail natural gas rates do not fully reflect the underlying increase in energy costs; and in some cases explicitly as gas taxes are temporarily removed.

Military spending is set to rise, as are efforts to more fully integrate the EU.

Spending on energy infrastructure – green and otherwise – should also increase.

Finally, in the most negatively affected countries, classic Keynesian fiscal policy may also be implemented. This would take the form of initiatives that simply add to economic activity, be they additional spending or tax cuts.

Is slower growth good?

In general, more economic growth is preferred to less growth. However, when economies are nearing their economic potential, that calculus changes.

The very reason central banks are raising interest rates is to prevent GDP growth from being too fast. This would overheat the economy and send it into a premature tailspin.

By the same token, if the war in Ukraine reduces U.S. growth by a few tenths of a percentage point while still leaving growth in the realm of 3% -- as we forecast -- that may well be a desirable outcome. It still represents economic growth that is around a percentage point faster than the normal rate of growth. But one doesn’t want extremely fast growth when the economy is already essentially at its potential.

As a simple thought exercise, the U.S. unemployment rate is now just 3.8%. If it were to continue improving at the rate managed over the last six months, it would tumble to just 2.4% by August. That would not only be below the pre-pandemic low of 3.5%, it would be the lowest reading dating back to World War II. It isn’t clear whether the economy could sustain such a low unemployment rate without generating a large amount of wage inflation. As such, it is probably best that growth slow significantly this year and fate not be tempted.

-With contributions from Vivien Lee, Andrew Maleki and Aaron Ma

Interested in more insights from Eric Lascelles and other RBC GAM thought leaders? Read more insights now.

1. “War in Ukraine will cripple global food markets,” The Economist, March 12 2022
2. Russia’s War on Ukraine threatens a global food security crisis,” The Financial Times, March 7 2022.


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Some of the statements contained in this document may be considered forward-looking statements which provide current expectations or forecasts of future results or events. Forward-looking statements are not guarantees of future performance or events and involve risks and uncertainties. Do not place undue reliance on these statements because actual results or events may differ materially from those described in such forward-looking statements as a result of various factors. Before making any investment decisions, we encourage you to consider all relevant factors carefully.

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