This economic outlook update takes place amidst heavy uncertainty brought on by the Russian invasion of Ukraine. The longer the duration and escalation, the greater the downside risks that build to the global and North American outlook.
We will only know with hindsight whether current risk premiums within financial and commodity markets will be validated, prove too optimistic or too cautious. This means that every forecast must be grounded with base assumptions that will need to evolve with geopolitical events. Our starting point assumes that the current elevated risk premia manifested in credit spreads and commodity prices remains in place through March and April. As a result, we expect WTI spot pricing to average $110 a barrel through the second quarter, marking a substantial revision relative to the pre-war forecast of $72 a barrel. Other energy prices, such as natural gas should also remain elevated, though the regional nature of supply means that North American prices will not follow Europe. Other areas where Russian and Ukrainian supply have influence, such as wheat, aluminum, and nickel, are expected to increase another 10% in the second quarter.
While the fog of war has elevated downside risks, market pricing on commodities is currently reflecting a combination of fundamentals related to current and potential supply mismatch, as well as a significant risk premium for the still-to-be-determined impacts. The latter creates significant volatility with two-sided risks. For instance, oil prices can quickly recalibrate lower on a positive sentiment shift if some OPEC members (mainly Saudi Arabia, UAW) even hint at commitments of higher production levels. The price of WTI oil swung from $130 a barrel to $104 within one trading day – landing it not far from its pre-war price that hovered at $90.
Still, the shock to commodity prices, even if it proves short-lived, will result in much higher near-term inflation. When combined with the likelihood of longer-term sanctions on Russia, this can leave prices at structurally higher end-points this year due to lags in reorienting supply chains, particularly against a backdrop where North American economies are already in excess demand. The net effect will weigh on real disposable income and take some steam out of consumption, particularly in Europe. Fiscal supports are already being announced within various economies to provide some relief to households and businesses. But, this is a double-edged sword. The extent to which these supports are broad across incomes and households may delay or limit the needed demand shifts that would ease pressure on key commodity markets with supply shortfalls. Likewise, this could have the unintended impact of maintaining higher inflation patterns than in the counterfactual outcome, creating an even thinner tightrope for central banks to walk along.
Amid all of this, the Covid-19 pandemic is still a factor on the outlook. Economic re-opening offers a fillip to activity, especially within the service-sector in economies moving away from restrictions. Job markets in both the U.S. and Canada are maintaining extraordinary momentum, recently surpassing expectations even among the most bullish. This offers both economies a strong backdrop to absorb the confidence and price pressures emanating from geopolitical risks.
This will keep central banks in tightening mode, at least for the next few meetings, since they are starting on a backfoot to withdraw emergency-level policy supports. The Bank of Canada and Federal Reserve both raised their policy rate in March and are expected to bring the policy rate to 1.75% by year’s end. The path of rate hikes is also more uncertain, highly dependent on the evolution of financial conditions and their impact on economic activity.
This publication focuses on the numbers, but if you’d like a deeper dive into underlying issues, including the impact of the war in Ukraine, please see our Question & Answer piece published February 23rd.
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|Economic Indicators: G7 and Europe|
|Global Economic Outlook|
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