- Energy and commodity prices are expected to remain elevated for some time before stabilizing.
- Central banks will weigh the effects of war, sanctions, and inflation to determine policy paths in 2022.
- Global economic growth will likely dip over the next few quarters as energy prices and interest rates rise.
Russia’s invasion of Ukraine has created high levels of uncertainty in the global economy. The war and widespread sanctions will likely have a knock-on effect on economic growth, inflation, interest-rate policies, and the future of renewable energy. We analyze the fluidity of recent events and their economic implications in this post.
Europe’s reliance on Russian energy
The United States and European countries have imposed multiple rounds of sanctions on Russia, including some restrictions on Russian banks. The economic sanctions will hurt Russia’s economy but are not likely to deter President Vladimir Putin’s government. Russia is a major commodity exporter of products including oil, natural gas, wheat, and base metals. Countries such as Russia and Iran do not typically abandon their ideology because of economic hardships triggered by sanctions. They have historically proved to be stubborn and resilient. Their economies fall into recessions and, eventually, adapt to these changes. Disruptions to energy supplies will directly impact oil and gas importers, mainly Europe. Russia supplies about a third of the region’s energy needs; almost 50% of Germany’s and 25% of France’s energy imports come from Russia. There is a possibility that Russia would cut off energy supplies in response to the sanctions or that the new set of sanctions include Russia energy. The worldwide energy supply was in a structural deficit before the Russia-Ukraine War given strong demand levels. Any disruptions can have dire consequences for a commodity that has inelastic demand in the short term. We believe oil markets will price in the possibility of a worsening war in Ukraine and further supply disruptions. Since the conflict is not likely to de-escalate any time soon — and could continue to simmer in the background — prices of oil and other commodities will likely remain elevated and can rise further. For more on our views on oil, see Oil prices may correct after sanctions-related spike.
ECB rates hikes are not a “zero” probability
The policies of central banks and governments will determine whether high energy prices lead to a sustained period of high inflation. In late 2021, several European governments announced subsidy programs and cuts in value-added taxes on gas and electricity bills due to skyrocketing energy prices. Now, many more European countries are stepping in with a mixture of price caps, tax cuts, and subsidies. Such measures could extend the duration of high prices and inflation as company and household balance sheets are in a relatively healthy state.
The European Central Bank (ECB) recently tempered its hawkish pivot on interest rates. The ECB will continue to wind down its asset purchase program over the near term. But policy normalization could be limited as signs of a slowdown emerge toward the end of 2022, in our view. The ECB could refrain from hiking its policy rate this year, but that is not a zero probability. Some members of the central bank’s governing council have signaled they would like to move away from a negative-interest-rate policy.
In the United States, the Federal Reserve has signaled it will raise interest rates several times this year and start the balance sheet runoff. Still, rising concerns about growth are likely to deter the Fed from accelerating the pace of tightening later in 2022, reducing the probability of an aggressive rate hike cycle.
Renewable energy in the cards
The Russian-Ukraine conflict could accelerate the pace of transition to renewable energy in the medium to longer term. European countries have ambitious carbon reduction plans, and the conflict may help facilitate the shift. In late February, German Chancellor Olaf Scholz halted the certification of the Nord Stream 2 gas pipeline designed to bring natural gas from Russia directly to Europe. Germany’s coalition government includes the Green Party, an environmentally focused political party.
In the United States, plans for a transition to using renewable energy are not as advanced as in Europe. But President Joe Biden’s administration has several items, such as harnessing power from wind and new solar projects, on its clean-energy agenda. An accelerated transition toward renewable and green energy could translate to higher conventional energy prices.
Finding equilibrium amid the conflict
All in all, energy and other commodity prices are likely to remain elevated over the short to medium term. But we expect prices to eventually stabilize. A resolution to near-term issues such as the energy supply squeeze and the conflict in Ukraine could bring about a downward move in oil prices, in our view.
Natural gas and wheat prices have spiked since the start of the Russia-Ukraine War
Source: Bloomberg, as of March 11, 2022.
Against the current backdrop, central banks may reconsider their policy options, including raising interest rates. Policymakers may respond to high inflation but with an eye on growth and recession risks. In our opinion, inflation will decline — gradually — to targeted levels. Global economic growth will slow over the next few quarters because of higher energy prices and rising interest rates, in our view. Therefore, this transition period can qualify as stagflation. Stagflation is not static and is unlikely to persist. But we think inflation and the risk of slow growth will be around long enough to keep the stagflation narrative alive.
For informational purposes only. Not an investment recommendation.
This material is provided for limited purposes. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, or any Putnam product or strategy. References to specific asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations or investment advice. The opinions expressed in this article represent the current, good-faith views of the author(s) at the time of publication. The views are provided for informational purposes only and are subject to change. This material does not take into account any investor’s particular investment objectives, strategies, tax status, or investment horizon. Investors should consult a financial advisor for advice suited to their individual financial needs. Putnam Investments cannot guarantee the accuracy or completeness of any statements or data contained in the article. Predictions, opinions, and other information contained in this article are subject to change. Any forward-looking statements speak only as of the date they are made, and Putnam assumes no duty to update them. Forward-looking statements are subject to numerous assumptions, risks, and uncertainties. Actual results could differ materially from those anticipated. Past performance is not a guarantee of future results. As with any investment, there is a potential for profit as well as the possibility of loss.
Diversification does not guarantee a profit or ensure against loss. It is possible to lose money in a diversified portfolio.
Consider these risks before investing: International investing involves certain risks, such as currency fluctuations, economic instability, and political developments. Investments in small and/or midsize companies increase the risk of greater price fluctuations. Bond investments are subject to interest-rate risk, which means the prices of the fund’s bond investments are likely to fall if interest rates rise. Bond investments also are subject to credit risk, which is the risk that the issuer of the bond may default on payment of interest or principal. Interest-rate risk is generally greater for longer-term bonds, and credit risk is generally greater for below-investment-grade bonds, which may be considered speculative. Unlike bonds, funds that invest in bonds have ongoing fees and expenses. Lower-rated bonds may offer higher yields in return for more risk. Funds that invest in government securities are not guaranteed. Mortgage-backed securities are subject to prepayment risk. Commodities involve the risks of changes in market, political, regulatory, and natural conditions. You can lose money by investing in a mutual fund.
Putnam Retail Management.