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Wednesday, February 23, 2022
The risks of oil zeroing in on $100
Believe it or not, the current Russia-dominated news cycle has at least a couple of bright spots.
The good news is that geopolitical events, like the one that sent the S&P 500 Index reeling into correction territory on Tuesday, tend to move the market in decisive yet mercifully short bursts. Eventually, Ukraine — just like North Korea’s showy displays of its rocket-launching prowess — will run its course as a source of investor anxiety. And the West’s tightening of the screws on Russia’s economy with sanctions will have limited impact for the global economy, given that it comprises a relatively slim slice of global growth.
Now comes the bad news. Russia — a nuclear power, permanent member of the U.N. Security Council and a major oil producer — is looking more and more like its hell-bent on reconstituting the failed Soviet Republic whether its neighbors like it or not, making extreme risk aversion the order of the day.
Those dynamics are igniting oil prices, which are commingling with inflation that refuses to come back to earth. It’s all wreaking havoc on policymakers’ Herculean efforts to keep price pressures from crushing consumers.
On Tuesday, Yahoo Finance’s Rick Newman covered how the Biden administration is moving to contain the “collateral damage” from surging energy prices on American consumers grappling with a monster case of sticker-shock.
However, there’s only so much that the White House can accomplish on that front. As a crude producer, Moscow benefits financially from an energy squeeze — and so do other OPEC economies reaping the benefits of strong demand and limited supply.
“Absent clear signs of a physical disruption in Russian crude supplies and a commensurate rise in prices, the current tension is unlikely to prompt any immediate move by OPEC+ to change its production policy,” Raad Alkadiri, a managing director at Eurasia Group, said in an analysis on Tuesday.
Only a disruption in Russian energy exports could alter that equation, Alkadiri wrote, adding that “there remains a risk that, faced with retaliatory sanctions, the Russian government will order some reduction in flows, if only to make the point that Europe is dependent on its energy supplies, and that Moscow retains the power to hurt the international economy."
The analyst added that "given the current tight market conditions, such measures would send oil prices well above $100 per barrel.”
The combination of slowing growth, higher inflation — and interest rates that are poised to go higher — is drawing an increasing number of comparisons to the 1970s, that chaotic era that featured gas lines, stagnant economic activity and, of course, skyrocketing prices.
It’s why observers like Mohamed El-Erian, president of Queens College at Cambridge University, told Yahoo Finance Live last week that an Eastern European crisis would send “a very strong stagflationary wind ... through the global economy.”
El-Erian suggested investors have not fully priced in the risk of a full-fledged armed conflict — and that’s where things could get interesting, but not in a good way. Already, economists think conditions are ripe for an unpleasant inflationary surprise.
“Arguably, economic conditions now are closer to those in the 1970s than they have been at the time of other similar geopolitical events. Inflation is already very high; labor markets are tight; and inflation expectations are rising,” said Jennifer McKeown, head of global economics at Capital Economics.
If tensions escalate, oil could easily top $120 per barrel, she said, while spurring natural gas prices as well. That could add 2 percentage points to headline inflation in developed economies — and for a reminder, U.S. prices running well above 7%.
“That might be enough to convince central banks to act more aggressively if they fear that associated increases in inflation expectations and wage growth will cause higher inflation to become sustained. But concerns about inflation would need to be weighed against those about economic activity,” McKeown wrote.
“Yet there could come a tipping point beyond which the conflict becomes serious or broad enough to disrupt economic activity in advanced economies, either due to the direct effects of sanctions, shortages and higher inflation or the indirect effects on consumer and business confidence or financial markets. This tipping point would probably come soonest in the euro-zone,” she added.
Buckle up.
By Javier E. David, editor at Yahoo Finance. Follow him at @Teflongeek
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