World Weighs Humanitarian, Economic Toll of the Ukraine War

The humanitarian cost associated with Russia’s invasion of Ukraine has come into plain sight as the war enters its second week. More than 1 million Ukrainians have fled the country, cities are being bombarded, and early reports indicate there are thousands of civilian and military casualties. It’s important to keep the human toll of this crisis in mind as we focus here on the economic facets of what’s happening.

Following the initial shock of Russia’s invasion, markets responded much as they have at the onset of past geopolitical conflicts. There is typically a sharp response in markets when a conflict begins, but they settle rather quickly and “price in” a new geopolitical, economic orientation. It’s what happened when Russia invaded Georgia in 2008 and Crimea in 2014. We saw hints of that happening in markets last week, though plenty of uncertainty remains around energy prices, fallout from economic sanctions and the potential for escalation.

Barring a shift in on-the-ground realities in Ukraine, Fed policy will capture significant attention over the next week or so as the Fed embarks on raising its key rate. It’s a challenging time for the Fed, as inflation is elevated. While we believe leading indicators for rising prices have already peaked, the recent conflict-driven commodity shock is a new variable that’s causing renewed inflationary pressure. A big question moving forward is whether rising prices tied to geopolitical uncertainty will impact demand and, therefore, put downward pressure on commodity prices.

Meanwhile, COVID-19 is also retreating around the globe, which is spurring renewed spending on restaurants, travel and experiences while shifting a share of wallet away from durable goods. As a key policy meeting draws closer, markets will be keen to see how the Fed describes inflationary pressures while also accounting for Ukraine.

Behind these crosscurrents, we see an economy with solid underlying fundamentals. We may finally be on the other side of the pandemic; the labor market is healthy; and despite inflationary pressures, spending and earnings are holding up well.

Wall Street wrap

Labor markets are in great shape: We’d classify Friday’s jobs report as a blowout. Roughly 678,000 Americans found jobs in February, according to the establishment survey. The prior two months were also revised upward by 92,000. Since the end of September, the economy has been adding jobs at a pace of 615,000 a month on average. Going deeper, 304,000 more Americans returned to the workforce, and by our count 1.6 million workers have stepped off the sidelines in 2022 thus far. That’s critical, as companies were short-handed for months, which contributed to inflationary pressures through 2021.

There is some concern that rising wages are contributing to an inflationary spiral (higher wages translate to higher prices, which cause wages to rise … repeat). But wage growth appears to be moderating as more workers are pulled in.

The unemployment rate now rests at 3.8 percent, a few fractions above its pre-pandemic level of 3.5 percent. Now, with the labor market in really good shape, business productivity will be a larger factor in growth. On that front, Q4 productivity rose 6.6 percent over Q3 (annualized); that’s well above the three- and five-year averages of 2.4 percent and 1.9 percent, respectively. With the labor market in really good shape but tightening, companies will now need to raise their productivity to keep economic growth moving along over the coming years. 

ISMs holding steady: The ISM manufacturing index rose to 58.6 from 57.6 in February (anything above 50 indicates expansion). Backlogs rose and export orders spiked, while prices paid and supplier deliveries remained steady. Basically, this tells us that business remains strong amid elevated — though stabilizing — price and supplier pressures. Keep in mind, the omicron variant remained a factor in February, which should make March’s report our first “post-omicron” view of the economy.

On the services side, the ISM index unexpectedly declined to 56.1 from 61.7 in February. It’s still a strong report, and orders are rising as the world reopens. We think you’ll see more improvement here in March as consumers continue to shift a significant share of spending to services.

Powell previews March policy meeting: Fed Chairman Jerome Powell on Wednesday hinted that a quarter-point rate hike would be the likely outcome of its upcoming policy meeting. Markets had considered chances for a half-point hike a few weeks back, following comments from Fed President James Bullard.

“I’m inclined to support a 25-basis-point rate hike,” Powell said Wednesday before the House Financial Services Committee. “It’s too soon to say for sure, but for now, I would say we will proceed carefully along the lines of the plan.”

Powell also added that the Fed would remain nimble given sizable economic uncertainty on the global stage. To us, that means the Fed will not only consult its forecasts and projections but will also “listen to markets,” as it has for years now. If economic data, inflation or markets turn negative against the Fed, the central bank will adapt rather than impose policy. For now, Powell believes the economy and labor market are strong enough to handle a quarter-point rate hike, even with headwinds blowing.

The week ahead

Of course, the world will continue to monitor the war in Ukraine and the machinations from the West and Russia. The situation can change on a dime, and it poses downside with escalation but also upside with a ceasefire or withdrawal. Here’s what else is in focus this week:

• Tuesday: The NFIB small business index for February will help us see if there are divergences between large corporations and smaller enterprises. Large companies, for example, have had an easier time hiring workers, raising wages and obtaining inventory. Does this remain the case, or are small business owners seeing improvement in labor, inventories and prices? Speaking of inventories, the broader wholesale inventories read for January is also due on Tuesday.
• Thursday: The big report for the day will be CPI, for reasons that need no explanation at this point.
• Friday: The week closes with the consumer sentiment survey from the University of Michigan. While omicron is retreating, the war in Ukraine may “cancel out” improvements in the outlook.

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