The world changed last week when Russia stepped up its invasion of Ukraine, leading the United States, European countries and their allies to impose increasingly severe financial sanctions. Although Western leaders were initially loath to ban purchases of oil, aluminum and other commodities from Russia, fearing that such a move would inflict significant financial hardship on their own citizens, the At the end of the week, it seemed increasingly likely that the United States and European countries would take these steps.
Financial market reaction was a flight to safe havens such as the dollar, developed market government bonds and gold. The reaction of commodity markets was both swift and violent. Yes, oil prices jumped and aluminum hit new highs, but that was just the beginning. The price of wheat, of which Ukraine is a major producer, has soared as supplies feared to be severely reduced. The Bloomberg Commodity Spot Index, which tracks 23 futures contracts, jumped 13% in its biggest ever weekly gain in data dating back to 1960.
So while inflation expectations as measured by the US bond market over the next five years have risen to their highest level since at least 2002, yields on longer-dated Treasury bonds have fallen. Additionally, major benchmark yield curves have contracted significantly, with the very wide spread between two- and 10-year Treasury yields narrowing to a minimum since March 2020 and the very beginning of the pandemic. This market response is not crying out for inflation, quite the contrary.
When the yield curve narrowed a few weeks ago, many analysts blamed it on concerns that the Federal Reserve would raise interest rates too quickly, which would ultimately slow economic growth. However, the action of the past week gave the impression that something had changed in the narrative. Economists were quick to understand the ramifications of rising oil prices, with a number pointing to prices of $150-$200 a barrel as the point where economic growth could quickly tip into recession. This is exactly the range for crude that some, including DWS Group’s Darwei Kung, a fund manager and the company’s head of commodities, say we are likely to hit if additional sanctions were imposed. It is not only oil that is rapidly rising in price, but also staples such as agricultural products like wheat and corn. But instead of eating or driving less, consumers have historically reduced spending in other areas to offset these higher costs.
A Bloomberg Intelligence report reveals that a one-cent change in the price of gasoline influences US consumers’ annual spending on fuel by about $1.1 billion. That would mean gas prices levy an energy “tax” of nearly $100 billion based on how gas prices have risen over the past year, and about to rise much more. In a note this week, Bank of America Corp. chief strategist Michael Hartnett said the war in Ukraine and subsequent commodity disruption “means a bigger inflation shock, a smaller rate shock and a larger recessionary shock”.
Sure, Americans are enjoying some of the biggest wage gains in decades, but that’s at a nominal level. The monthly jobs report released on Friday showed wages jumped 5.1% from a year earlier, but were down 5.7% in January. Moreover, it does not even keep up with inflation. The government is expected to say this week that the consumer price index rose 7.9% in February from a year earlier, according to data compiled by Bloomberg.
In this environment, it makes sense that yields on benchmark 10-year Treasuries fell to 1.73% from over 2% in mid-February. Yes, there are concerns about the Fed raising rates too quickly in a slowdown in economic growth. And yes, the central bank still holds a significant portion of the national debt, which keeps benchmark yields lower than they would otherwise be. However, this decline in yields is different. This is a suggestion that the momentum of the world’s largest economy is not strong enough to withstand the commodity shock we are seeing now, especially at a time when the Fed has little ammunition to act.
This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.
Lisa Abramowicz is co-host of “Bloomberg Surveillance” on Bloomberg TV.