Russia’s invasion of Ukraine could deliver another blow to a U.S. economy that’s already expected to slow after a blockbuster 2021 while driving oil prices and inflation higher and intensifying supply chain snarls.
“We’re looking at the tensions via the prism of an economy that’s recovering from COVID, global supply chains are really stressed, and we have a high inflation environment,” says Gregory Daco, chief economist at EY-Parthenon. “The tensions will further fuel inflation and further stress supply chains.”
Keep in mind the U.S. isn’t nearly as vulnerable to the conflict as Europe, which gets about 30% of its oil from Russia, compared with about 3% for the U.S., says Tom Kloza, chief global analyst for the Oil Price Information Service. The likeliest scenario of Russian troop deployments in Ukraine that cause simmering strains for weeks or months likely would have a modest impact on U.S. economic growth, Daco says.
But a war, he says, could significantly curtail economic output as it hammers consumer and business confidence.
The U.S. economy grew 5.7% last year, the fastest pace since 1984, as reopening businesses, strong job growth, rising wages and government stimulus money sparked robust consumer spending and business investment. But low-income households have largely depleted their savings and the initial burst of outlays is largely played out.
Like many economists, Daco still expects healthy growth of 4% this year, excluding any effects from the Russia-Ukraine conflict. In January, despite the spread of coronavirus’s highly contagious omicron variant, employers added a booming 467,000 jobs and retail sales surged 3.8%. That led some economists to revise up their first-quarter growth forecasts from below 2% to 2% to 3%.
Here’s how the Russian invasion could crimp this year’s gains:
Energy prices
Russia is the world’s second-largest oil producer behind the U.S., churning out about 10 million barrels a day, Kloza says. The U.S. benchmark oil price was up nearly $2, or about 2%, to $93 in mid-afternoon trading Tuesday in response to the conflict’s recent escalation.
So far this year, the standoff has added $10 to $20 to the crude price on fears of a growing crisis that disrupts supplies, Kloza says. Prices, he says, also have been pushed up by increasing global demand and less production from the U.S. and Saudi Arabia.
The conflict could disrupt Russian oil supplies through sanctions that President Joe Biden slaps on Russia or Russian retaliation to U.S. sanctions, say Daco and economist Rubeela Farooqi of High Frequency Economics. Kloza believes both possibilities are unlikely because Russia doesn’t want to lose oil revenue and Biden doesn’t want to burden American consumers with even higher gasoline prices.
Under the most likely scenario of continued tensions, Kloza believes crude will top $100 and the average unleaded gasoline will rise from $3.53 a gallon to just over $4 in the second quarter before drifting down to about $3.30 the second half of the year. Higher pump prices lead Americans to rein in spending.
A war, however, would intensify sanctions and physically disrupt the flow of goods across the region, Daco says. That could propel crude to $125 to $150 and drive average unleaded gasoline to $4.50, Kloza says, pinching shoppers even more.
Supply chain problems
The standoff is also pushing up prices of other commodities such as wheat and aluminum that are exported from the region, Daco says. A war could further drive those costs higher as it hampers the shipment of such goods.
Inflation
Higher oil and commodity prices likely would stoke inflation that hit a 40-year high of 7.5% in January. The effects could add as much as a percentage point to consumer price increases, Daco says.
That, he says, could prompt the Federal Reserve – which is expected to raise its key interest at least three times this year – to hike more sharply, raising borrowing costs for households and businesses.
Markets
Higher energy and commodity prices can hurt the earnings of U.S. corporations while Fed rate increases drive investment dollars from stocks to bonds. Both are bad news for markets and the S&P 500 index is already down about 5.6% this month amid fears that the crisis could intensify. Goldman Sachs predicts a further decline of 5% to 6% if war breaks out.
Consumer and business confidence
Falling stocks and fears of rising prices and interest rates can easily ripple to the broader economy, Daco says. Businesses may pull back investment and hiring, damping job growth. Consumers, in turn, may rein in spending.
A possible bright spot is that falling stocks and other problems may prompt the Fed to raise rates more gradually.
“They don’t want to move in a way that will crush the recovery,” Farooqi says.
But Daco says that may be less likely in this case because the crisis could worsen inflation, which the Fed is intent on squashing,
The good news: Top economists and stock analysts still see war as unlikely. In that case, the hit to markets, inflation and interest rates should be modest. Economic growth overall could be trimmed by perhaps two-tenths of a percentage point to 3.8%, Daco estimates.
“Recent market reactions to the Ukraine crisis have been sharp, but they largely represent fear,” says Brad McMillan, chief investment officer for Commonwealth Financial Network. “Fear over what could happen, not what is happening. Ukraine, while a significant geopolitical event and potentially a human tragedy, will have minimal direct effects on the U.S. economy.”
A war, however, would be another story and could reduce 2022 growth by as much as a percentage point, Daco says.
