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Global recession risks rise after Russia invades Ukraine: Kemp -Breaking

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© Reuters. FILEPHOTO: Containers are being picked up by trucks at Los Angeles’ Port of Los Angeles. Los Angeles, California. U.S. Nov 22, 2021. REUTERS/Mike Blake

John Kemp

LONDON (Reuters) -U.S. and European economies are facing a heightened risk of a recession this year as Russia’s invasion of Ukraine severely disrupts supply chains and causes inflation to accelerate to the fastest rate since the 1970s.

Yields on U.S. government debt maturing in two years’ time are trading less than 30 basis points below notes maturing in ten years, the narrowest spread since the pandemic erupted worldwide in early 2020.

In recent years, the Yield-curve Flattening indicator has proven to be one of the best indicators of an impending economic recession. It measures the current stance in monetary policy relative long-term rate expectations.

Spread is currently in the 77% percentile for all the months since 1990. That’s an increase from the December 58th and 33rd percentiles this year.

In the last three decades, whenever the spread has narrowed this much it has heralded either a significant mid-cycle business slowdown or an end-of-cycle recession (https://tmsnrt.rs/3HFAGIr).

Before the invasion, the prices of energy, commodities, parts for industrial machinery, and consumer goods were at their highest since the mid 1980s.

The conflict in the Middle East and the sanctions that were imposed by the United States as well as its allies has seen oil and gas prices soar even more.

Among other areas, severe disruptions were reported in international shipping, passenger and cargo air travel, and global supply chains of chemicals and automakers.

This is equivalent to massive global production capacity loss. It is a supply-side shock which is likely to increase inflation and depress output.

Companies that are facing sanctions and supply chain issues, as well as the rapid escalating costs of inputs, will be less inclined to make risky investments.

The higher prices of gas, electricity, fuels and cars will mean that households are forced to cut back on their expenditures.

As global supply chains become more stretched, recessionary forces are rapidly intensifying across North America as well Europe.

POLICY DILEMMA

The U.S. Federal Reserve finds itself in a dilemma between two goals: to maximize employment and preserve price stability.

The pressure on the central bank to increase interest rates quicker to contain inflation, but keep them lower in order to counter the increased uncertainty that comes with the conflict is simultaneous.

Senior U.S. policymakers indicated that the urgency to control inflation is greater than other factors and plan to increase interest rates starting this month.

According to the fed funds futures markets, traders anticipate that the central bank will raise interest rates six quarter points (or the equivalent) before the end of this year in an effort to control inflation. However, this is slightly less than the seven increases expected prior to the invasion.

Similar contradictions have led to a slowdown or recession in the business cycle over the years.

Economic policymakers and economists love to claim that expansions are not fatalistic. Also, economic expansions do not stop naturally and unavoidably but when the Fed makes policy more restrictive.

This is false. Policymakers do not deliberately “murder” expansions. The explicit goal of monetary policies is not to create a recession.

Instead of sustaining growth, recessions occur when policymakers must sacrifice the long-term goal of supporting expansion to achieve a faster and more urgent goal like reducing inflation.

Policymakers will face this dilemma in 2022 because of the deadly mix of price rises and disruptions to supply, as well as increased uncertainty for households and businesses, and slower growth in employment and output.

Recession risks are even greater in Europe because region’s economic integration with Ukraine and Russia and greater exposure to surging international gas prices will magnify the size of the supply shock.

Before the invasion of Ukraine, Fed and other central bank faced the difficult task of creating a soft-landing that would control inflation instead of a hard landing that would lead to a recession.

Because of the impact that conflict has had on supply chains, it made this job much more challenging and raised the possibility that an attempt to soften the landing would fail.

Other columns:

Reuters: Oil prices and oil consumption are under threat from an inflation shock (Reuters, February 10)

– Fed searches for elusive soft landing (Reuters, Feb. 2)

– Escalating U.S. inflation forces macro policy rethink (Reuters, Jan. 13)

Reuters Oct. 14, 2014: Inflation is the biggest threat to global economy

John Kemp works as a Reuters analyst. His views are his alone

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