With the Ukraine War in full swing, Federal Reserve Chairman Jerome Powell may have to pause his expected 0.25 to 0.50 rates hikes to the Federal Funds rate, something anticipated at the March 15 meeting to the Fed’s Open Market Committee [FOMC[ meeting. Allianz SE chief economist Mohamed El-Erian, currently President of Cambridge University, said with the war going world markets are no too unstable to tolerate rates hikes while the Ukraine War looms over Europe. JP Morgan predicted nine 25-basis point rate hikes in 2020, raising the Federal Funds rate to 1.75% by year’s end. El-Erian thinks at the very least the Fed will scuttle any talk of 50-basis points hikes until the Ukraine situation settles down. “This takes 50-basis point completely off the table,” El-Erian said. “It takes the eight to nine hike a lot of people were talking about for this year off the table . . .and thankfully so ”
Like the Covid-19 pandemic that plagued the world for the last two years, Powell admitted he didn’t know what to do to mitigate the effects of the pandemic on the U.S. economy, other than to keep monetary policy loose. Now that war broke out in Ukraine, Powell, according to El-Erian, will think twice before hiking rates. “I didn’t think the U.S. economy could accommodate and live with such slamming of the brakes of monetary policy,” El-Erian said, hoping the FOMC would reconsider its rate hike plan for 2022. No one knows where the Ukraine War will go, with Ukrainian forces now actively battling Russian troops. As casualties mount, no one knows whether 79-year-old President Joe Biden and NATO will put boots on the ground in Ukraine. Tightening monetary policy during a time of war could plunge the economy into recession, with or without U.S. troops involved.
Inflation, which the Commerce Department measured at 7.5% in January for a 40- year high could spike to 10% with disruptions in petroleum and natural gas supplies. Record pump prices in the U.S. have already hit consumers hard, driving as slowdown in consumer spending, a sign of a slowing economy. No one knows yet the effect on worldwide petroleum and natural gas production because of Russia’s ongoing campaign in Ukraine. Given Russia’s multi-front invasion and attempt to degrade Ukraine’s military infrastructure, Putin could keep the campaign going for a while. If Ukraine mounts fierce resistance like it has in Kiev, Kharkiv, Odessa, Maiupol, the war could drag on for some time causing disruption in world oil and natural gas supplies. Biden got Germany to suspend indefinitely the Nord Stream 2 natural gas pipeline that was due to supply Germany cheap Russian natural gas.
El-Erian admitted that postponing rate hikes could fuel more inflation in the U.S. because of supply chain shortages, especially when it comes to energy. Biden’s approach to energy was to shut down domestic energy production, especially the U.S. fracking industry, extracting oil for tar sands in the upper Midwest. Biden signed onto the pie-in-the-sky renewable energy proposals that came out of the Glasgow Climate summit, further suppressing U.S. oil and natural gas production. Ukraine’s war squeezes supply chains, if, for no other reason, energy traders are all panicking, not knowing what to expect. Ell-Erian thinks Fed rate hikes now are stuck in a “very unsatisfactory situation,” trying to step double-digit inflation. El-Erian predicted that if a war breaks out in Europe it would create “stagflation” in the U.S., harking back to the late ‘70s and early ‘80s when inflation ran rampant.
El-Erian thinks the Fed will be forced to pause its rate hike plan with the Ukraine War looming over global financial markets. “The Fed is going to have to be even more careful, and it’s going to have tolerate higher inflation,” El-Erian said. El-Erian said that runaway inflation historically leads to recession, especially when the Fed is forced to tighten monetary policy. Powell already stopped quantitative easing, letting the Fed buy back its own debt. Powell knows that geopolitical events, like the Ukraine war or the Govid-19 global pandemic present problems for the Fed’s FOMC to determine the right balance between rates and higher inflation. Powell knows how to extinguish inflation but he also know he must create as soft landing for the economy. Crashing the economy would be on his head if he hikes rates too aggressively. El-Erian thinks the Fed is stuck with inflation for a while.
No one knows at this point how long the Ukraine War will go or whether the U.S. and NATO will eventually jump in, something that would have catastrophic effects on U.S. and world markets. Right now the Ukraine War is a distant land, far removed from the U.S. economy, despite current shortages of natural gas and petroleum. El-Erian thinks from his vantage point in Cambridge, he doesn’t think the Fed will go ahead with its plan to start hiking rates until there’s more clarity on Ukraine. “This is a situation everyone was afraid of,” El-Erian said. “That by being late, you have fewer policy options,” meaning the Fed should have started hiking rates last year. But with Powell dealing with the economic effects of Covd, he was reluctant to start tightening. Now the Ukraine War gives him pause to hit the economic brakes too quickly. Putin’s Ukraine invasion threw the world economy for a loop.
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