March 1st, 2022

Stagflation is Coming

Dear Retail Investor,

On Wednesday, the US and other western nations rolled out economic sanctions on Russia that included halting the Nord Stream 2 pipeline project, which would funnel gas from Russia to Germany. US President Joe Biden vowed that he would “take robust action to make sure the pain of our sanctions is targeted at the Russian economy, not ours.” 

But given that Russia is one of the world’s top exporters of oil, natural gas, wheat, copper, nickel, aluminum, palladium, and platinum among other critically important commodities, that may be easier said than done. 

Putin launched a full-scale attack on Ukraine shortly after Biden’s announcement, showing the world that Russia doesn’t necessarily care about western economic sanctions.

Markets responded immediately. The price of oil surged past $100 shortly after news of the invasion broke, amid fears of a supply crunch. Prices of wheat, palladium, platinum, nickel, and aluminum also soared higher. In Europe, where 40% natural gas is supplied by Russia, natural gas futures soared 60% higher on Thursday amid fears of supply disruptions. 

Life is About to Get More Expensive

In early February, JP Morgan analysts projected that oil prices could push past $120 per barrel if there were disruptions to oil flows from Russia.

“The concern is that Russia would somehow curb oil exports if they really felt backed into a corner,” Patrick De Haan, head of petroleum analysis at GasBuddy told Vox

Russia has delayed shipments of natural gas before, when Germany delayed the approval of the Nord Stream 2 pipeline. “Who knows? Maybe Russia will do that again with oil,” added De Haan. “That’s certainly a nightmare situation, but it could happen.”

It isn’t out of the question, because Russia has found an ally in China. A review of World Bank and United Nations trade data shows that since 2014, when the west imposed sanctions on Russia for annexing Crimea from Ukraine, China has emerged Russia’s biggest export destination:

Russia has been strategically distancing itself from western trade allies and specifically the US for years. On February 4th, as tensions escalated between Russia and Ukraine, Putin signed a 30-year contract to supply gas to China via a new pipeline. The new gas sales will be settled in euros, in line with the two nations’ efforts to diversify away from the US Dollar

So what does it mean for you, dear retail investor? 

The markets will be very volatile as the Russia-Ukraine situation plays out. But with global energy prices surging higher, the post-Covid economic recovery that was underway will be stifled. When energy prices rise, these elevated costs move through the supply chain, increasing prices of consumer goods and impacting consumer spending. As we know, inflation reached at a 40-year high last month.

Many economists are now warning we are in for a period of stagflation, a combination slower economic growth, high inflation, and rising interest rates. The Fed, which had planned to roll out its money-tightening policies in March with the first of several planned interest rate hikes, may need to re-think its strategy now.

“Arguably, economic conditions now are closer to those in the 1970s than they have been at the time of other similar geopolitical events. Inflation is already very high; labor markets are tight; and inflation expectations are rising,” Jennifer McKeown, head of global economics at Capital Economics told Yahoo Finance

Hold on to your hats – we are in for a bumpy ride.

Dear Retail Editorial Team 

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