First Covid, Now Inflation and the Risk of Recession

Analysis –

The outlook for the U.S. economy, and by extension Hawaii, may have just darkened.

Just as we were told we can drop our masks, planes began arriving again full with tourists, and large floating white petri dishes full of tourists arriving off our island shores signaled things were gearing up for a 2019 economic reunion. But this reunion of the “good old days” met a new global economy of tangled supply chains struggling to get back or go forward into what is now a new normal.

Three factors arrived on the scene about the same the time, and now threaten a supercharged inflation cycle, and/or too deliver to our island communities the risk of another recession.

Three things to watch out for in the coming weeks and months:

Number One

Global Shortages – A new Covid wave hit China and has led to major lockdowns and further stress to the world’s struggling supply chains. The Chinese government has responded to this latest Covid outbreak with an iron fist forcing factories to suspend operations, including manufacturing affiliated with Apple, Toyota and Volkswagen.

The backlog of container ships waiting off Qingdao, one of China’s biggest ports swelled to nearly twice as many ships queued up Monday as at the end of February. These bottlenecks are expected to further drive skyrocketing container freight prices (even) higher, and by extension higher costs for the items within those containers. All this is very bad timing for the Fed attempts to bring inflation under control.

The only possible economic upside in China’s factory shutdowns is reducing immediate oil demand, now reflected in commodity futures as the global demand for oil seesaws producing headlines as in… “U.S. oil tumbled on Monday, breaking below $100 per barrel, amid talks between Russia and Ukraine as well as new Covid-19 lockdowns in China.”

Number Two

Disruptions in Commodity Markets, including energy are further riled from Russia’s unprovoked invasion of Ukraine. Oil and natural gas prices have climbed in recent weeks as governments and individual corporations have placed new restrictions on transactions with Russia. Even as oil prices have fallen back a little in the past few days, they remain unusually high, and drivers can expect little price relief at the pump for the near future.

Equally worrisome are rising prices for other commodities produced in Russia and Ukraine, which together supply nearly a third of global wheat exports, with the Ukraine planting season, usually occurring now, totally disrupted by war. Even before the war, global stocks of wheat were low, and prices high, thanks to unfavorable climate-change driven growing weather over the past two years. In the wake of Russia’s invasion, wheat prices have skyrocketed, threatening to boost food inflation more broadly.

Number Three

Higher Interest Rates, and a corresponding tightening in overall financial conditions. The Fed is widely expected to raise interest rates at its meeting this week. Given that U.S. inflation is already at a 40-year high, this is hardly surprising.

In a different era, few would have predicted that interest rates could be at zero when inflation hit nearly 8 percent (as happened in February). With 20/20 hindsight, Fed officials likely agree that they should have begun their money tightening months ago. Fed officials, for good reason, had delayed taking on interest rate hikes earlier for fear such actions would derail a post-pandemic recovery.

For the Fed to engineer a “soft landing” in this hot economy is going to be a difficult task at best. It just got more difficult in light of recent global events placing the Fed and the future interest rates factors being pulled in different directions at the same time.

Meanwhile, Chinese supply chain problems and Russia/Ukraine commodity market disruptions are widely expected to push overall inflation even higher, which would normally nudge the Fed to raise interest rates faster. But those same forces are also expected to drag down economic growth, which usually suggests the Fed could raise rates more slowly.

It certainly didn’t help that the Russian invasion of Ukraine arrived at the perfect time for further global disruptions, perhaps Putin intended it to be that way, a momentary opportunity to further upset the global supply and demand equilibrium, and take along with him a world of consumers and suppliers (along with Russia) for ride to an unknown and unlikely destination.

It’s not obvious what path the Fed will take to tame inflation without tipping the U.S. into an another recession cycle. Stay tuned…but this time around we have the added elements of war and embargos to multiply economic and social unknowns.