Analysts explain how the Ukraine war is increasing US risk

Photo: Reuters

The crisis in Ukraine is naturally impacting on risk profiles for countries across Europe, both east and west.

Yet there are implications, too, for the US, which had been rising in Euromoney’s country risk survey, as the economic recovery from the pandemic continued.

The US ended up at 18th on Euromoney’s global risk leaderboard on a total risk score of 72.3 out of a maximum 100 points after last year’s moderate improvement.

That leaves it in the second of five risk categories, on a par with low-risk Germany and Iceland.

All of its macroeconomic risk factors improved last year, except for government finances, which was downgraded and is also the lowest scoring. Political and structural risk factors also improved, barring the scores assigned for corruption and infrastructure.

These score changes resulted from the values assigned by various country risk experts taking part in Euromoney’s crowd-sourcing survey.

Like their European counterparts, US experts are now having to assess what the crisis means for the investor outlook.

The US is geographically distant from the theatre of war, but nevertheless involved as the principal actor in Nato, and vulnerable to global commodity price increases and any potential economic downturn in European export markets.

If the experts agree on one thing it is that it will have at least some impact, although the overall effect is not so easy to quantify until more is known about how the war will pan-out, given all the other issues that are going on.

Pablo Guerron, a professor at Boston College, believes that if the war is not resolved, “there is the significant risk of global recession”, with the implication clearly that the US is not insulated from it.

That is enough justification alone for risk scores to be adjusted.

Robert Neal, a professor at Indiana University, concurs by stating his scores will undoubtably fall. “Economic risk is rising, political risk is rising and institutional risk is rising,” he says.

However, Lorenzo Naranjo, senior lecturer in finance at Washington University in St Louis (WUSTL), says the crisis itself has not affected any of his scores, highlighting both different starting levels perhaps but also varying interpretations as to how much the crisis is currently a factor.

Everyone seems to agree there will be some impact on prices, albeit only adding to a pre-existing problem that has been developing since the pandemic regardless of the fighting in Ukraine.

Consumer price inflation has accelerated sharply in the US during the past year from 2.6% in March 2021 to 7.9% in February – a 40-year high – on the back of supply chain and logistics problems, plus wage pressure after huge fiscal and monetary policy stimuli to keep the country running during the pandemic.

This week the Federal Reserve finally responded with its first rise in the funds rate since 2018, a 25 basis points increase that it has signalled will be one of several during the coming months.

This raises the target range for its key rates from 0.25% to 0.5%, while the other monetary policy stimulus, namely asset purchases, is being withdrawn.

I don’t see the west willing to normalize trade relations with Russia after the atrocities committed in Ukraine 

 - Pablo Guerron

This is little surprise to Steve Hanke, professor of applied economics at the Johns Hopkins University, who issues a reminder that “inflation is always and everywhere a monetary phenomenon”.

“The M2 money supply aggregate has grown by a cumulative 41.2% since February 2020, for an annualized growth rate of 19.7% per year. M2 is still growing at 12.6% year-over-year,” he says.

Hanke believes the Ukraine crisis will “increase the relative prices of oil, gas and food, but those are relative price changes”, he emphasizes.

“They are components of, but do not drive, the overall price index,” he says. “The level of the price index is determined by the rate of growth of the quantity of money, broadly measured, in the hands of the US public.”

Indirectly, the war may affect the rate at which the Fed tightens monetary policy, he says, but to meet its inflation target of 2%, the Fed is going to have to raise interest rates enough to slow down the money supply growth to about 6%.

Boston College’s Guerron notes the fact the dollar has strengthened in recent weeks, so inflationary pressure from imported goods is partially mitigated.

At the same time, the global production of wheat and fertilizers is adversely impacted by the war in Ukraine. This will most likely push food prices up in the US, he says, and there will be pressure on the Fed to raise short-term interest rates faster than planned before the conflict started.

Guerron adds that rising interest rates will slow down growth in the US, but should not push the economy into contraction, although if the war escalates there is the possibility of recession.

“In this scenario, fiscal policy will be severely limited due to the high levels of debt due to the pandemic,” he says.

WUSTL’s Naranjo notes the fact demand for government securities by big asset managers and pension funds has given many governments poor incentives to decrease their fiscal deficits.

“US government debt is now almost $30 trillion,” he warns. “This is a huge number when you compare it with the US stock market capitalization, which is around $54 trillion.”

I believe, if anything, it will show China that they cannot survive without the west 

 - Lorenzo Naranjo

Neal at Indiana University believes the impact on core inflation – excluding energy and food prices – will be smaller, at least for the next few quarters. He also reckons the US embargo of Russian oil will not have a notable impact on the global price.

“Oil is highly fungible and there are multiple global sources,” he says.

“As long as Russia is able to sell its oil to China or another country, global supply and demand will be largely unchanged. This was reflected in the market reaction to the embargo announcement. President Biden announced the embargo around 9am, and the end-of-day oil futures price was little changed from the 9am price.”

Neal says his interpretation of the Biden administration’s energy policy is that they made a choice to limit US energy production in an effort to drive up oil prices and thereby make green energy alternatives more economically viable.

These actions provide a large subsidy to the oil exporting countries of Russia, Iran and Venezuela, he states.

Guerron says that eventually oil supply will meet current demand.

“With a price hovering around $90, it seems economically counter-productive not to produce enough oil to meet the demand,” he says.

Venezuela, he adds, could therefore play a “black swan role” in oil markets.

Lorenzo adds that the current level of oil prices allows previously unprofitable operations to become profitable again. Even though this will take time to happen, eventually many shale oil producers will increase their production.

“Furthermore, the US electricity mix has diversified significantly in recent years and renewable energy sources now represent 20% of the current electricity mix,” he says. “There is still ample wind-generation potential that has not been exploited. This should put a stop to increases in oil prices.”

The crisis is also a challenge for Joe Biden’s presidency ahead of the mid-term congressional elections scheduled for November.

Guerron points out that, before the conflict, Republicans were well-positioned to take control of the Senate and with all likelihood the House.

“President Biden has managed the conflict with moderation, gaining support from both parties. However, if the conflict were to escalate, I see some chance that Democrats would retain the chambers because the public may be reluctant to change political direction in a period of turmoil.”

Naranjo also believes the crisis will impact on the mid-term elections.

“When you see what the far-right and left in Europe say about this crisis, even though they all condemn Putin and the Ukrainian invasion, they all agree that it was an expected Russian reaction,” he says.

“I think that Trump supporters will bring similar arguments and this might convince some voters to come back to the Republican side.”

The conflict may be resolved, of course, if both sides can reach a peace agreement, and hopefully without the use of chemical or nuclear weapons, but it seems clear the effects will be long-lasting.

Guerron suggests that international trade will be fragmented for the foreseeable future.

“I don’t see the west willing to normalize trade relations with Russia after the atrocities committed in Ukraine,” he says. “As a result, we will see global trade gravitating around two centres: the west headed by the US and allies, and the east with China as the main player. Russia will move to the east bloc.”

Naranjo says that neither China nor the US would like to get involved in a conflict of this nature.

“The [US] relationship with China has always been very pragmatic and both countries are deeply interwound with each other,” he says. “I believe, if anything, it will show China that they cannot survive without the west.”