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Teneo Insights Takeaways – Economic and Market Risk in the Midst of Global Disruption

April 14, 2022
By Kevin Kajiwara

From Russia’s invasion of Ukraine and seismic shifts in the world of energy to increasing inflation and the risk of a global recession, businesses are navigating an unprecedented minefield of volatile and interconnected geopolitical threats. Steven Rattner, Chairman and CEO of Willet Advisors LLC, Economic Analyst on MSNBC’s Morning Joe, contributing writer to The New York Times, and Counselor to the Secretary of the Treasury and “Car Czar” under President Obama, joins our host Kevin Kajiwara for a wide-ranging discussion on global markets, the energy revolution and the political outlook.

 

Listen to the Call

 

Current State of the Economy

Despite an 8.5% year-on-year inflation rate (a 40-year high), there are some positive economic signs as well. The unemployment rate is down to 3.5%, and there are more job openings than the amount of people seeking  employment in the U.S. Wages are rising at an unusually high rate of 6% and GDP is also expanding. Inflation, however, has overshadowed these gains. We have seen double-digit price increases for everything from furniture, to food, to energy. External factors such as the pandemic and the war in Ukraine are contributing to rising inflation, as are bad policy decisions.

Stimulus programs, especially the American Jobs Plan that passed in the Spring of 2021, created close to $2.3 trillion of excess savings in household bank accounts. Stimulus spending created supply chain bottlenecks as the economy could not cope with rising demand and ultimately led to surging inflation levels. The Fed also kept interest rates at zero and bought several trillion dollars in securities to prevent a stalled recovery and head off criticism for doing too little. Dialing this back now will likely require interest rates to go up substantially higher than the market is currently anticipating, which could result in a recession.

Further Causes of Inflation

Supply chain issues and bottlenecks are starting to be resolved, which could help ease inflation.  But there are two key issues that could complicate the supply chain again. One is that China is still trying to enforce its zero-COVID policy by locking down huge sections of their population, including Shanghai and Shenzhen, which are major manufacturing areas. The other is the war in Ukraine, which is interrupting the flow of raw materials that come out of Russia and Ukraine. The Fed will need to decrease the deficit and raise interest rates above the inflation rate if they want to lower inflation, which is likely to lead to a recession in 2023 or 2024.

The Fed Taking on Extra Responsibilities

The Fed has been forced to take on responsibilities that should be resting with fiscal authorities and other political figures. Washington and Congress have been gridlocked, and therefore haven’t made progress on issues such as climate change and diversity, equity and inclusion. They have tried to push these responsibilities on to the private sector and the Fed. However, the Fed current mandate is limited to addressing price stability, employment and inflation.

Gas Prices

President Biden has taken several actions aimed at reducing the price of gas, including releasing one million barrels a day from the Strategic Petroleum Reserve. However, these efforts are unlikely to have a serious effect on gas prices. The war in Ukraine has accelerated the rise in already-climbing oil and gas prices and, despite the Biden administration’s efforts to make voters believe they are doing all they can to lower gas prices, we are unlikely to see a significant decrease before midterm elections.

Future Prospects for the Economy

The market is always very sensitive to interest rates, especially at the moment. Raising interest rates, which is necessary to reverse inflation, will drive down values and stock prices of companies. If inflation ends up worse than most people are predicting, interest rates will be higher than most people expect, which will then bring down the market quite a bit. Growth will also slow, and there will be almost nowhere to safely invest your money other than perhaps commodities and energy.

ESG Investing

Many companies are self-sanctioning by refusing to do business with Russia, despite not being mandated by law to do so. Shareholders and customers are putting a lot of pressure on companies to behave in a certain way, which is an important part of the free market. This kind of pressure is fine as long as this pressure isn’t coming from the government. The government shouldn’t force companies to solve problems that are the government’s responsibility, but shareholders and customers should be free to pressure companies in any way they see fit.

Energy Transition

The war in Ukraine has revealed Europe’s poor handling of the energy transition. Germany has shut down 14 of their 17 nuclear plants and are burning coal instead. The Netherlands shut down their biggest gas field, and the UK gets a large amount of power from unreliable wind and renewable sources. These are important lessons for the U.S.’ energy transition.

There needs to be a tax on carbon to drive up gas prices to force an energy transition. Additionally, we need the revenue from gas taxes to maintain our transportation infrastructure. It is too early to stop drilling or attempt to put all fossil fuel companies out of business as we need fossil fuels during the transition. Finally, we need to be more willing to accept nuclear power as part of the solution. The current licensing requirements for a nuclear power plant drives the cost so high that no one has built a new nuclear power plant in the U.S. in a very long time.

Use of Sanctions and Power of the Dollar

Short of a military invasion, economic sanctions are one of the most effective tools available for keeping order in the world and punishing bad actors. However, the ability to effectively sanction Russia is limited by the fact that the U.S. and Europe need the materials that Russia exports. No Russian export has been sanctioned yet because of this.

People have suggested that overusing sanctions could cause the international community to move away from the dollar, but they don’t yet have an effective replacement to move to. Russia has tried to diversify their foreign exchange holdings, but once they were shut out of the world payment system, their $630 billion in foreign currency was effectively frozen and rendered unusable. Therefore, the U.S. is still in charge of the world’s financial system and the dollar is likely to remain the unit of exchange around the world.

The views and opinions in these articles are solely of the authors and do not necessarily reflect those of Teneo. They are offered to stimulate thought and discussion and not as legal, financial, accounting, tax or other professional advice or counsel.

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