The financial market volatility witnessed since Russia’s invasion of Ukraine almost a month ago has subsided somewhat. Global equities have begun to trend positively. Bond yields have reached new highs for the year. Oil prices have retreated somewhat, as have other commodity prices. Nevertheless, the military conflict in Ukraine remains very active and unpredictable. This week, the U.S. Federal Reserve raised its Federal Funds Rate for the first time since 2018. We provide a brief update below.
The war in Ukraine is understandably top of mind for most people. Investors remain predominantly focused on whether this conflict will be limited, in both duration and scope, or has the potential to become more drawn out and broader, involving NATO (North Atlantic Treaty Organization) countries.
Recent comments from Ukrainian and Russian officials have led investors to believe that there may be a glimmer of hope that some compromise and ceasefire can be reached. There are, however, long lists of demands from both sides which need to be addressed. In addition, some of the regional and geopolitical experts we follow have expressed skepticism regarding the potential for a truce at this point, suggesting that peace ultimately depends on Russia’s President, Vladimir Putin, whose objectives remain unclear. Many of these analysts have speculated that, given the military and economic costs borne by Russia, Mr. Putin may only end the war when he can demonstrate a form of triumph in front of the Russian public. It is unclear what that could look like, but investors should be prepared for a wide range of outcomes.
The U.S. Federal Reserve began its anticipated rate hiking campaign on March 16th. Predictably, the Fed noted that Russia’s invasion of Ukraine will create additional inflationary headwinds, while at the same time weighing on economic growth. The Fed raised its estimate of core inflation over the next few years, while lowering its forecasts for U.S. economic growth. While these adjustments may seem troubling, Chairman Jerome Powell provided some reassurance by emphasizing that the U.S. economy is performing well and that the probability of recession in the near future is low.
The Fed, like other central banks, seems to be more concerned at this juncture about inflation than about growth. Fed officials have suggested that they may raise interest rates six more times this year, and another three times next year, in a rather aggressive attempt to ensure that inflation does not become entrenched. The Fed also indicated that it may announce plans to begin to reduce its holdings of bonds on its balance sheet in the next few months. This is another meaningful step toward normalizing monetary conditions over time, with the goals of both reducing inflationary pressures and returning to a neutral monetary stance.
Inflation is an important risk to the investment outlook over the intermediate term. The military conflict in Ukraine will only exacerbate current price pressures because of the potential disruptions to supply chains across a range of commodities. Fortunately, the economies in North America, particularly the United States, are starting from a position of reasonable strength and can handle some degree of higher interest rates and goods and services costs without triggering an economic recession.
Should you have any questions, please feel free to contact us.