- With inflation in the major economies of U.S. and Europe soaring, the Russian invasion of Ukraine has just thrown a spanner into the works for central bankers who were otherwise committed to tightening monetary policy.
- Medium term, stagflation conditions tend to favor real assets, commodities, small cap value stocks and emerging market assets.
There couldn’t be a worse time to be a central banker than now. With inflation in the major economies of U.S. and Europe soaring, the Russian invasion of Ukraine has just thrown a spanner into the works for central bankers who were otherwise committed to tightening monetary policy.
Whereas earlier on, central banks could argue that the bulk of inflationary pressures were caused by pent-up demand from the pandemic and supply chain snarls, the looming energy crisis because of the war in Ukraine will complicate matters considerably.
The world’s largest bond market, that for U.S. Treasuries meanwhile is signaling concern that the war in Ukraine could lead to a nightmare scenario that the U.S. Federal Reserve would rather avoid – persistent inflation and weak economic growth, otherwise known as stagflation.
While growth continues to be strong in the U.S., high energy prices could very easily derail the economy.
Even as bond-market gauges of short-term inflation soared last week against a backdrop of surging oil and natural gas prices, short and long-term yields narrowed, indicating heightened expectations of an economic slowdown.
The U.S. Treasury market provided temporary safe harbor for investors in the early stages of the Russian invasion, which sent stocks plummeting, but equities have since rebounded, with yields rising as well (yields rise when bond prices fall) as investors bet that the Fed would be slower to hike rates given the uncertain outlook.
With around two weeks to the Fed’s mid-March meeting, expectations are that the Fed will raise policy rates from near zero, and any sign at hesitance to hike further could see a temporary boost for risk assets.
Medium term, stagflation conditions tend to favor real assets, commodities, small cap value stocks and emerging market assets.
