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Market Extra: Russia-Ukraine puts 10% U.S. inflation on radar as BlackRock repeats central banks may have to live with inflation

The threat of a full-scale Russian invasion of Ukraine is raising the risks of an energy supply shock, which some economists say could send the annual U.S. inflation rate up to 10% at some point from 7.5% as of January.

That’s the view of RSM chief economist Joseph Brusuelas and BNY Mellon’s Daniel Tenengauzer. In a phone interview Tuesday, Brusuelas says such an energy shock would shave 1% from U.S. gross domestic product over the next year, and boost inflation by 2.8 percentage points over the next three to six months before price gains can ease once the Russia-Ukraine crisis stabilizes.

Read: Oil and natural-gas prices surge after Russia orders troops to Ukraine

A 10% year-over-year gain in the consumer-price index would be the highest since October 1981. It would also come as a surprise to even some of the most sophisticated traders — who are bracing for annual CPI to peak at 8% in March before drifting down to 4% next January, according to market-implied levels derived from fixings.

The warnings come as the world’s largest money manager reiterated its view that central banks may be forced “to live with” inflation. That’s because aggressive rate increases to combat supply-driven inflation “would only torpedo economic activity that has not yet fully recovered,” BlackRock Investment Institute’s Jean Boivin and others wrote in a note Tuesday.

“There’s clearly some uncertainty around the reaction function of global energy markets to an invasion,” said Brusuelas of RSM, a consulting firm. He said a full-scale war in Europe would send the price of Brent oil
BRN00,
-0.56%

BRNJ22,
-0.56%

to roughly $110 a barrel, or around 14% above where it stood Tuesday.

See: What war in Ukraine would mean for markets as Putin orders Russian troops to separatist regions

Under an alternative scenario, oil could even rise by up to 40%, which would in turn push CPI even further above 10%, the Austin, Texas-based economist told MarketWatch.

“It depends on the severity of sanctions and what happens on the ground. There are all sorts of variables here you can’t quantify or predetermine,” he said. What’s more certain is that “inflation is not going to move back to target over the next year or two, households are going to have to live with higher inflation than they’ve experienced over the past four decades, and financial markets are going to experience volatility.”

Commodities Corner: Russia’s move into Ukraine is boosting commodity prices — here’s what’s at stake

Germany’s decision to halt certification of the Nord Stream 2 gas pipeline, which was built to pump natural gas from Russia to Germany, “is no small joke,” said Daniel Tenengauzer, head of markets strategy for BNY Mellon in New York. The pipeline would double the capacity of the existing route from Russia to Germany, and natural gas alone would “have a very meaningful medium-term impact on inflation over the next few years,” he said via phone.

Although economists are forecasting CPI to fall to 3.3% in the fourth quarter of 2022, down from 7% at the end of last year, “there’s a higher probability today of headline inflation overshooting the consensus and last year’s number — resulting in inflation perhaps touching 10%,” Tenengauzer said Tuesday. “It’s all going to be defined by where energy prices go from here. And by energy, I mean oil, natural gas, and a whole bunch of other things, even coal prices.”

The unfolding Russia-Ukraine crisis is compounding the risk of stagflation amid a variety of unrelated shocks. Aside from the pandemic are climated-related considerations, from China’s sustainability drive to “the lack of wind in Europe,” and supply constraints “have exceeded all expectations in terms of scope and persistence,” according to Rabobank strategists Richard McGuire and Lyn Graham-Taylor.

For his part, BNY Mellon’s Tenengauzer says he’s focused on China’s zero-tolerance policy on COVID-19, particularly in Hong Kong where city officials are considering targeted stay-at-home restrictions if needed to contain an outbreak of cases.

U.S. stocks ended sharply lower Tuesday, with the S&P 500 index
SPX,
-1.01%

falling into its first correction in two years as the Russia-Ukraine conflict escalated. Meanwhile, Treasury yields were generally higher, with the 10-year rate
TMUBMUSD10Y,
1.943%

trading around 1.94%.

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