The Russian invasion of Ukraine has begun, constituting the most serious security crisis in Europe for decades. Markets are responding with equities selling off, bonds rallying, gold and the US Dollar rising, oil/energy prices surging sharply, and the Russian markets being the most affected.
Geopolitical risk and economic and policy uncertainty today have the world on edge. How do central banks assess geopolitical unrest and its effects on the domestic economy? In the world’s largest economy, the US Federal Reserve will hold its regularly scheduled meeting on March 16–17.
The anticipated actions of the Federal Open Market Committee (FOMC) is that it will raise interest rates to weaken inflation. But in light of current events, the chances of it raising rates by 50bp at that meeting, which seemed likely only several weeks ago, have all but vanished.
In our opinion, the Fed will raise rates because inflation has (by February-end) sharply risen to 7.5%, and could go higher still as energy prices rise and the effects of the Russia–Ukraine conflict repercuss through the global economy.
The key question now is what happens for the rest of the year. Markets had come round to the view that several rate hikes would be required to bring inflation back under control and our own opinion was that short-term real interest rates would have to move into positive territory given the size of the inflation shock.
Looking into Asia, while its macro outlook is not inter-twined with Russia or Ukraine, countries are expected to encounter macro duress from higher oil prices. However, despite rising inflation worries across Asia, the market’s policy-pricing of the region’s central banks have not shifted much.
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Developing countries in Asia who are net-importers of energy and commodities, and have high weights for fuel and food in their CPI baskets, such as India, Thailand and the Philippines, are particularly vulnerable. When the average annual price of oil is expected to surge by 10%, we anticipate an additional 0.2 to 0.3ppts increase in yearly inflation, 0.2 to 0.3ppts reduction on annual current account positions (expressed as % of GDP), and a GDP growth hit amounting to -0.1 to -0.2ppts at these countries.
Being net-exporters of energy and other commodities, countries like Malaysia and Indonesia will likely fare better. They also have greater policy space to smooth out retail energy price spikes without impairing fiscal and external balances. Overall, since most of developing Asia has only recently begun emerging from the pandemic, output gaps of these markets have yet to close. As such, we expect developing Asia’s central bank policy normalization to lag that of the Fed.
Developed Asia, such as Singapore, Korea and Taiwan, will feel the pinch from rising fuel prices as well. However, with strong global manufacturing and demand for semiconductors, output gaps of these markets have closed, labour market slack has dissipated, and production and exports remain buoyant. As a result, we expect their central banks to continue tightening.
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Rising energy prices, tightening USD liquidity and higher risk premia will weigh on currencies and equities across the region. Net commodity exporters who stand to reap terms-of-trade windfalls will fare relatively better. But it will take a speedy localization of the Russia-Ukraine conflict or a standstill agreement or an armistice -- for energy prices and risk premia to begin reversing course. Otherwise, further monetary policy and deeper long-term supply-side adjustments will become necessary.
Aninda Mitra is head of Asia macro and investment strategy at BNY Mellon Investment Management
