Federal Reserve Decision Complicated By Another Hot Inflation Number and Russian Invasion of Ukraine

FS Insight Team

The Fed’s preferred inflation measure, the personal consumption expenditures (PCE) index came in very hot at for 2021 at 6.1%, which was the highest level in 39 years. This level was the highest reading since 1983. The Russian invasion of Ukraine has already caused commodity prices to spike and for oil itself to reach the highest prices since 2014. The spread between Brent and WTI is widening. Most of the short-term and medium term effects of the conflict and sanctions has been to raise energy prices.

Economist Mark Zandi of Moodys estimated that the effect of the runup and the conflict is probably accounting for about $10 to $15 dollars of the price per barrel right now. That means if the effects are sustained it could add 30 or 40 cents a gallon at the pump. This would add roughly half a point a year to inflation according to Zandi. The Fed’s main priority seems to be inflation right now. However, sustained impact from the conflict and sanctions could result in growth concerns mounting over time. Russia and Ukraine together account for nearly a third of all grain exports.

It appears for the time being at least that high-yield credit is not deteriorating to problematic levels. However, if the conflict escalates the hardest sanctions that are being put off now may end up being implemented. Right now sanctions have escalated to a pretty significant level of sanctioning both Putin and Foreign Minister Lavrov. However, Europe is economically dependent on Russia’s energy exports and wants to hold off on certain sanctions that may shock their economies and leave them undersupplied at a time of year when it is still very cold in northern Europe. These could have the effect of exacerbating current price spikes, shortages, and supply chain issues.

Powell had quite a tricky task ahead of him already. However, this task is made more complicated by the added uncertainty from recent events. Chairmans Greenspan, Bernanke, and Yellen have never seen a situation where they tightened into rapidly rising energy prices. They either were done tightening or it contributed to them putting off tightening. Not since Chairman Volcker walked the Eckles building have similar circumstances occurred. The odds of a 50 bps has continued to decline in the wake of the invasion since we mentioned the decreasing likelihood last week. 

The only Fed official to give a speech in the wake of the Ukraine invasion is Governor Waller. He urged that the FOMC take a hawkish course similar to that recently advocated by Governor Bullard. He laid out a detailed case for why he believed the Fed should raise a whole point by the end of the year. His speech can be read here. Most other Fed officials who spoke since the invasion were non-commital compared to Waller though, who was giving a planned speech. Richmond Fed President Thomas Barkin said “time will tell” when asked about the events. 

The Fed nominations of the Biden administration, including Powell’s own have been blocked by the Senate Banking Committee Republicans because of concerns over Sarah Bloom Raskin’s comments on op-ed where she inferred using supervisory powers to further climate change goals and her ties to a Colorado FinTech company. The tapering of monthly purchases of $80 bn of Treasuries and $40 bn of MBS began in November and was accelerated in December. The Fed is on track to taper down to no more asset purchases by its March meeting, but still has around $30 bn in securities to purchase. The Fed will be done with asset purchases in mid-March 2022 at this pace.  The benchmark yield on the 10-Year Yield closed at 1.97%

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