Macroeconomic & Geopolitical

Seven Predictions Amid the Rising Unpredictability

March 2022 – 3 min read

As the Ukraine War spirals toward broader geopolitical conflict, some elements of the outlook are already coming into view.

Market volatility these days confirms just how rudderless investors feel and just how few historical precedents they find helpful. Is this more like the Lehman Brothers Crisis when markets seized up? Or does it echo the September 11 attacks that shook assumptions about threats to global security? Is it as significant as the construction of the Berlin Wall, or is it more like the Bolshevik Revolution? And what are the effects of sealing off all relations with the world’s 11th largest economy?

One thing that is absolutely certain is that the strong economic recovery from two years of pandemic looks in doubt. Forecasts of moderating inflation as supply chains return to normal are off the table, too.

The fundamental drivers of this current uncertainty are fears that continuing violence in Ukraine will spill into neighboring countries and bring Russian troops into combat with NATO. But even as we contemplate that terrifying vision, some elements of the outlook are already abundantly clear.

More Unpleasant Surprises: This may not seem like a helpful prediction, but not all the market losses to come will be obviously linked to this part of the world. Russia’s financial crisis in 1998, together with stress in other Asian markets, led to the failure of U.S. hedge fund Long-Term Capital Management, which nearly brought with it some of the world’s most-exalted banks. This shock is very different, but it will still reverberate as unexpected losses cause damage through unexpected exposures. The headlines around a Chinese nickel producer that nearly failed because of billion-dollar margin calls on the London Metals Exchange won’t be the last of the surprises ahead.

Higher Energy Prices: No matter how soon a settlement may come, Russia will not be seen as a reliable supplier of oil and gas for a long time. Europe may not be able to turn off Russian energy as quickly as the United States, but Moscow’s invasion will accelerate diversification to other suppliers and the global transition to renewable alternatives. In an energy market that is already tight, that means higher prices than anyone was modeling a month ago.

Food Shortages: Russia and Ukraine together normally export one-third of the world’s wheat, but not this year—or next. Ukraine’s current exports cannot reach its ports, and next year’s crops need to be planted soon, sending prices up more than 40% so far. Russia’s ban on fertilizer exports will shrink harvests well beyond its borders. More expensive food will add further pressure to rising prices in Europe and the U.S., but higher prices and the threat of actual shortages means that countries like Egypt, Tunisia, and Lebanon will be bracing for riots.

Bigger Deficits: Governments will need to consider subsidies to help absorb the spikes in fuel and food prices. And this spending will be on top of European promises to boost military capabilities and accelerate the climate transition that will reduce dependence on Russian fossil fuels. This comes hard on the heels of a COVID spending spree that has already driven government debts to record levels.

Tighter Money: What was always going to be a difficult year for the world’s monetary authorities just turned even tougher as they balance rising inflationary pressure with the need to support growth. Initially, they will likely be very cautious given market volatility and political uncertainty. Commodity shocks will also hurt consumer demand and detract from growth. But inflation looks persistent, too, and the textbooks aren’t very helpful on what monetary settings are best in moments of stagflation.

G20 Collapse: The economic coordination mechanism that helped manage the recovery from the Global Financial Crisis in 2008 seems to face an existential challenge as rifts deepen among its largest members. The United States, Europe, and Japan may find it much more helpful to return to their G7 meetings given what are likely to be much more caustic conversations with Russia, China, and even India.

Triumphant Dollar (and Euro): Having just inflicted an unprecedented economic blow to Russia, the American and European currencies look more powerful than ever. Some central banks may opt to diversify into gold or Chinese yuan, but that strategy has hardly saved Russia from devastating costs. Most of what is bought and sold in the world is still denominated in dollars and euros, and a currency that cannot trade in and out of these two becomes essentially useless. A quick look at the Bitcoin chart confirms that most crypto alternatives aren’t really alternatives either.

If few of these seem like bold predictions, they may at least serve as bearing points until the big questions around continuing financial shocks, fractured supply lines, and rising global insecurity look more settled.

Christopher Smart, PhD, CFA

Chief Global Strategist & Head of the Barings Investment Institute

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