A Look at Higher US Inflation Resulting From the Ukraine War

We will look at three items regarding higher inflation:

• Driving forces
• More acute in Europe
• After the shock of war

Driving Forces:

Prior to the war in Ukraine, disinflation in the US was widely indicated by the leading indicators. The timing of that transition from rising inflation to diminishing inflation is delayed, and inflation will reach a higher peak as higher energy prices (oil, natural gas, gasoline, diesel) hit our economy as a result of the war and ripple through many aspects of our lives. Because of energy prices and other factors, we took annual average Consumer Price Index (CPI) inflation for 2022 up two full percentage points to 7.6% (12/12 rate-of-change forecast average for the year). This encompasses a 3/12 rate-of-change peak of 8.4% in the second quarter of 2022 as a forecast average.

We now expect oil (West Texas Intermediate) to average above $100 per barrel through 2022 and the first quarter of 2023. That alone provides something of a floor for expectations in 2022. Consistent with oil price pressures, we raised our outlook for copper (the metal that leads so many other commodities). We are forecasting that copper will rise approximately 26% from the February 2022 close before its ascent is over. The upside would be even greater, in our opinion, were it not for the mitigating influences of a stronger US dollar and the slower growth of China’s economy. Between oil, copper, nickel, and other commodities, the CPI inflation outlook had to rise. Keep in mind that commodity prices are more volatile and rise higher (and sink lower) than the CPI measure of inflation.

Our current outlook for the CPI rate of inflation, oil, and copper is predicated on our examination of:

• Prior wars
• Prior supply-side shortages
• Perceived supply-side shortages
• Inflation spikes (think 1970s)

We averaged these occurrences and also used best-fit cases based on current trends to drive our forecasts. The above means that these are “wartime forecasts.” They reflect the unique forces of this combination of variables. The forecasts will be reformulated based on normal business cycle dynamics once the war is concluded or trends are otherwise normalized.

More Acute in Europe:

The inflation impact of the war is more likely to be acutely felt in Europe in general, and perhaps Germany in particular. The German economy has a high dependence on Russia for energy. France may be impacted to a lesser degree because France has remained steadfast in its reliance on nuclear power. The anticipated greater inflation, particularly stemming from energy prices, is expected to be a more serious drag on our allies. As we have been demonstrating in our talks these past several weeks, high oil prices in the US have a tendency to alter the rate of rise in retail sales, but not turn a retail sales rising trend into a declining trend. The more acute price hikes in some European countries could be problematic.

After the Shock of War:

Disinflation occurs when macroeconomic growth dissipates (as was indicated by leading indicators in 2021). Keep in mind that inflation at the CPI level tends to be a lagging economic factor. Disinflation is still projected to characterize 2023 based on the following assumptions:

1. The Russian invasion does not spread to encompass other countries, especially a NATO country.
2. Nuclear weapons are not deployed.
3. Normal economic forces come back into play, either because the war ends or the war is pushed from the forefront of the news cycle.