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Economic Update on Ukraine

March 25, 2022

In times of conflict, markets tend to react to what is going on in the world — so how might the Russia and Ukraine war be affecting the US economy? Catch our newest TrendsTalk episode with ITR CEO and Chief Economist Brian Beaulieu to learn more.



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The below transcript is a literal translation of the podcast audio that has been machine generated by Rev.

Hello, I'm Brian Beaulieu, CEO and Chief Economist for ITR Economics. And welcome to this edition of TrendsTalk. We're dealing with an update on the impact of the war in the Ukraine. It always makes me pause because we have to deal with the economics of it, and we all know that there's a tremendous human tragedy going on, that didn't need to occur. We can't speak to that. We have the same feelings as everybody else, but you're here because we provide economic analysis, not societal humanitarian analysis. We're just going to speak to the economics of what's going on.

So far, the US remains relatively untouched by this, except for the inflationary aspect, which I'll deal with in just a moment. But crucial to maintaining our soft landing scenario in '22, '23, despite what's going on in the war, are several key factors. One is, since February 24th, we've been very closely monitoring how the consumer is fairing.

We're using the Johnson Redbook data that looks at weekly activity, and that is still in trend. We're looking at the stock market, which is really holding up well with all this going on. We had the correction going on before the war began. The market tends to rally on the sign of cannons, so we're trying to digest exactly how much of this is real economics, how much of it is the cannons, but we can say that it's not careening downward, which would be very detrimental to our soft landing forecast and for most of our businesses.

We're seeing that interest rates are not behaving in a very squirrely manner. The yield curve is steepening, which is good. It's the inverse yield curve where flattening of the yield curve till it goes inverse, that is a dangerous side for the economy. Long bonds are up and they're likely padding the delta between what the marketplace is indicating industry should be and what the Federal Reserve is going to be, so that's a normal relationship going on there. But it's the inflation quotient that is the abnormality so far.

We ran the analysis and we did something different for ITR. We ran a war time forecast for oil, copper and other commodities. And these forecasts are only going to be in place for as long as the war continues to impact people's expectations, drives the headlines, et cetera. When the war is no longer an issue, either because the war has ended or because it's turned into the Russian equivalent of Afghanistan, that we're going to find that more normal economic relationships return, more disrupts those relationships. So far, it's key that those relationships vis-a-vis the consumer haven't been disrupted. But for energy they have been, and we want to know if these higher energy prices are they going to hurt retail sales.

These higher interest rates said they're going to hurt housing home prices. Taking that step by step in terms of these high gasoline prices, and while everybody's talking about them, so far, they're not changing the retail sales trends. Indeed, if you look back over history, which is what we tend to do, we see that it can alter the slope of the rise, but it doesn't turn the rise into decline. We've been looking at an altered slope to rise, which means the question then becomes, are we're going to have the flattening that we saw, or the mildest slope become a little bit milder because of these high energy prices? Yeah, we think so. But that doesn't mean it turns into a hard landing. As long as that consumer is driving retail sales of higher, it indicates overall consumption continues to go up.

In terms of the interest rate increases going on, not enough is likely in our opinion, in terms of interest rate rise, to really push down on housing starts. We're looking at a very modest rising trend for 2022 because of pricing, but the prices, by the way, aren't high enough in of themselves to freeze that market, stop it from rising. Because we looked at home pricing, mortgages actually, as a percent of disposable personal income, their very favorable numbers right now. Housing prices are likely to continue to rise. We looked at, home prices are existing in new median prices in relation to interest rates and other things like energy prices, and it's not likely going to knock that rising trend back into a declining trend or even a flat trend for any appreciable time. It's a slower rate of rise, which is again, consistent with what we saw coming.

It's not clear that the war in Ukraine is having any impact on our economy. Nothing that we need to worry about at this time. The higher inflation is going to be something that we all are going to have to contend with. In the near term it looks like labor rates that we're paying aren't quite keeping up with these very high rates of inflation, unless you're giving out something greater than an 8% inflation rate. But if you do an 8% COLA (editor's note: COLA refers to Cost-of-Living Adjustment) to your people, it's because you're responding to these current very high rates. And as oil comes back down, as the war becomes less of an issue, and certainly given the supply chain improvements that we're seeing, and I know there's still COVID out there, I know that shipments going into Russia are still complicated because of the cetera.

But overall shipments are moving better. Supply chain shipments are moving better than they had been a year ago, six months ago. It's a step in the right direction. And all of that means under normal economic circumstances, we're going to have disinflation. These inflation rates are going to be coming down so we don't need to be giving 8% COLA's left and right. You have to look at the average over the time. Maybe if you do it based on the rear view mirror or what the average is going to be going forward.

We have a disinflation low out there in 2023 that's very similar to what we had before the war, at around 2.5%, It was 2.25% before, so very similar. And then went to the next round of inflation. This inflation is here to stay. It's just going to be happening at varying levels. We're already seeing some of the disinflation by the way, in terms of food products, which is very encouraging, because that hits people very directly.

Overall, expect oil to remain high. It's going to remain in that 105 to 115 maybe 120 range for 2022 is our expectation unless the war ends. Inflation's going to remain above where we previously expected it to be by a couple of percentage points until we get into that disinflation in 2023. But through it all, history tells us, given that incomes are rising, nominal and real will get caught up. Anybody who wants a job can have a job. Saving levels are good. They're not stupid good, but they're still good. Business liquidity is high. The B-to-B sector looks like it's doing well. We're monitoring all these things, but so far it's steady as she goes in terms of our soft landing forecast, despite the events going on in Ukraine.

Keep on keeping on. Figure out how you're going to pass through the cost increases because they're real, but also have this slow growth mode in mind rather than anything else. These interest rates are higher, right? We got a 10 year bond yield at about 2.3%, but when inflation's running near 8%, that's still a negative interest rate. We just talked about that at a webinar yesterday. There's still so many things going right in the economy that I think it'd be a mistake to assume otherwise, unless this war is going to expand beyond the one country. If it went into Poland, it'd be such a different ballgame. If they were using nukes, that would be a totally different ballgame, also in terms of the economic impact, let alone the human devastation. But we're not there. We don't know if we're going to go there. No one does.

Knowing what we have in front of us, you should plan on growth. It's probably going to surprise you that we're this resilient in our economy. It's going to be different, slower, more difficult in Germany and other parts of Europe because they don't have much closer ties to that situation. The main angst for us are semiconductor chips and the neon that the world was getting out of Ukraine economic system, so it's not like there's no problems involved here, but that's not enough to take us down.

I hope this has been helpful. I'm Brian Beaulieu, ITR Economics. See you next week.


Since 1948, we have provided business leaders with economic information, insight, analysis, and strategy. ITR Economics is the oldest privately held, continuously operating economic research and consulting firm in the US. With a knowledge base that spans six decades, we have an uncommon understanding of long-term economic trends as well as best practices ahead of changing market conditions. Our reputation is built on accurate, independent, and objective analysis.