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WAR SCRAMBLES EUROPE’S HOPES FOR ECONOMIC RECOVERY
As Europe’s economy struggles to right itself after the Omicron surge and a storm of inflation, Russia’s attack on Ukraine has dashed hopes for a smooth return to any kind of pre-COVID “normal.”
Europe’s energy prices had spiked as much as fivefold last fall; the war has now sent them higher, with Brent crude briefly trading as high as $139 a barrel after Russia’s invasion.
Italy’s statistics agency said rising energy prices will shave 0.7 of a percentage point from its economic growth this year.
The European Union (EU) is scrambling to replace Russian oil and gas, mainstays of the region’s economy and, on 8 March, outlined a plan to free itself from that dependency by 2030.
The EU also has banned Russian iron and steel products.
The war “will have a material impact on economic activity and inflation through higher energy and commodity prices, the disruption of international commerce, and weaker confidence,” Christine Lagarde, president of the European Central Bank (ECB), told a 10 March press briefing.
“The risks to the economic outlook have increased substantially,” she said, and noted that the bank will consider all options in responding to events.
The Eurozone faces “a high probability of recession if the situation doesn’t normalize quickly,” chief economist Christophe Barraud at Market Securities told Bloomberg.
Also on 10 March, the ECB’s policy committee confirmed its previously announced plan to end its €1.85-trillion bond-buying program by April and revealed a decision to wind down its older bond-purchasing stimulus arrangement before this year’s fourth quarter (see related story in this issue).
Until now, the older program had no fixed end date.
Inflation in the Eurozone rose to 5.8 percent in February, a jump from January’s 5.1 percent.
At its 10 March meeting, the committee also raised its inflation outlook for this year to 5.1 percent, almost twice the 2.6 percent it had forecast three months ago.
The bank sees inflation settling to 2.1 percent in 2023 and 1.9 percent in 2024. The ECB’s target inflation rate is 2 percent.
At the same time, the central bank trimmed its economic forecast for the Eurozone to a 3.7-percent expansion this year, no longer the 4.2 percent it predicted earlier.
Goldman Sachs paints a gloomier picture, pegging the region’s growth at 2.5 percent this year, compared to its pre-war forecast of 3.9 percent.
“The prospects for the economy depend on the course of the Russia-Ukraine war and on the impact of economic and financial sanctions,” Lagarde said.
The war is a “watershed for Europe,” she added.
The bank has left its -0.50 interest rate unchanged and set no time for it to change (see related story in this issue). Lagarde said the rate would increase “some time after” bond purchases end.
While the Bank of England has hiked rates and the U.S. Federal Reserve is poised to do so this week, the ECB is more cautious because Europe’s inflation is being driven primarily by energy prices over which the bank’s policies have little influence, The New York Times said.
TREND FORECAST: Unless this trend is reversed and the Ukraine war ends with a peace treaty and the Western sanctions slapped on Russia are lifted, prices will continue to rise higher, forcing Europe into a recession before this year is over.
G7 ENDS RUSSIA’S “MOST FAVORED” STATUS
The G7 nations—Canada, France, Germany, Italy, Japan, the U.K., and the U.S., with the European Union (EU) as a participating guest—have severed trade ties with Russia and deemed it no longer a “most favored nation.”
The “most favored” status enables a country to trade with others on preferential terms established by the World Trade Organization.
As a result, Russian exports will incur higher tariffs when they arrive in G7 countries and the EU, if any continue to be accepted.
The EU has banned Russian iron and steel products; the U.S. will not import Russia’s diamonds or vodka, among other products.
The group also has ensured that Russia will not be able to obtain financing from global financial institutions such as the International Monetary Fund and the World Bank.
In addition, the G7 countries say they have taken steps to prevent Russia from using cryptocurrencies to evade sanctions.
TREND FORECAST: The further the U.S. and NATO push Russia away from their economies, the closer Russia will build its ties with China, India and African nations. Again, as we note, these sanctions will hurt the Russian people, not the Kremlin. And, not only will they do nothing to end the Ukraine War, the worsening economic relations will foster more geopolitical tensions.
UKRAINE SUSPENDS NEON EXPORTS FOR CHIP INDUSTRY
Ukraine, which supplies half of the neon used by the world’s semiconductor manufacturers, has ended all shipments because of its war with Russia.
Neon is an essential element in the lasers that are used to etch chips. Its market price has risen as much as 500 percent this year.
The industry used about 450 metric tons of neon last year, data service Technet reported.
As much as 55 percent came from the two Ukrainian companies Cryoin and Ingas, both of which have shuttered their operations because of the war.
"If stockpiles are depleted by April and chipmakers don't have orders locked up in other regions of the world, it likely means further constraints for the broader supply chain and inability to manufacture the end-product for many key customers," analyst Angelo Zino at CFRA said in a Reuters interview.
Ingas was producing 15,000 to 20,000 cubic meters of neon per month for customers in China, Germany, Korea, Taiwan, and the U.S. The chip industry used about 75 percent of that, according to company data cited by Reuters.
The company is located in Mariupol, which has been heavily bombarded by Russian forces.
Cryoin, which processes about 10,000 to 15,000 cubic meters of neon per month, is in Odessa. The firm ceased operations on 24 February to ensure workers’ safety, the company told Reuters.
The neon Ukraine firms process is a byproduct of Russia’s steel industry.
China is also a significant source of chip-grade neon, but the gas from China is becoming more costly and is subject to the geopolitical ploys of the government there.
Neon prices jumped 600 percent just before Russia seized Ukraine in 2014, according to data from the U.S. International Trade Commission.
Companies in other locales could produce neon but it could take as long as two years to create production lines able to serve commercial markets, Richard Barnett, chief marketing officer of data firm Supplyframe, told the FT.
No companies are likely to make that investment until it becomes clear that Ukraine’s supplies are not coming back, he said.
TREND FORECAST: The loss of a key source of neon will worsen the chip shortage, shrinking production of electronic goods around the globe, heightening inflation, and pushing the world closer to a recession.
RATINGS AGENCIES AGAIN DOWNGRADE RUSSIA’S BONDS
Once again, Fitch Ratings has downgraded Russian bonds, this time from B to C, saying that it expects an “imminent” default.
The 9 March decision was Fitch’s second ratings reduction in seven days on Russia’s debt.
"Developments have, in our view, further undermined Russia's willingness to service government debt," Fitch said in announcing the reduction.
"More generally, the further ratcheting up of sanctions, and proposals that could limit trade in energy, increase the probability of a policy response by Russia that includes at least selective non-payment of its sovereign debt obligations," the statement noted.
Moody’s also cut its ratings on Russian bonds on 9 March.
S&P Global has downgraded Russia’s sovereign debt twice since it attacked Ukraine.
Worsening matters, international sanctions on Russia may have rendered $41 billion in contracts insuring Russia’s repayment worthless.
On 9 March, contracts insuring $10 million in Russian bonds for five years were priced at $4.6 million on signing, followed by annual premiums of $100,000, ICE data revealed.
International sanctions may trigger credit-default swaps and prevent the bonds being used to settle the contracts, analysts at Citigroup, Vanguard, and CreditSights wrote in research notes cited by Bloomberg.
The swaps market now is pricing in a 40-percent chance of a Russian default over the next 12 months and a 65-percent likelihood within five years, ICE Data Services reported.
Russia is scheduled to pay $117 million on dollar-denominated bonds on March 16. Another $5 billion of international debt will come due by early 2024.
Russia made a payment on a ruble-backed bond on 9 March. However, Russia’s central bank has banned transferring funds to foreign investors, so it remains unclear how Allianz, Blackrock, and other bondholders can receive what they are owed.
“This will likely be a technical default,” Vanguard’s Nick Eisinger, co-head of emerging markets fixed income investments, told Bloomberg.
The world’s biggest settlement systems Eurocler and Clearstream are no longer handling Russian assets.
“Western governments’ resolve to cut off Russia from the international financial system, combined with a potentially weaker willingness on the part of the Russian government to service its debt on time and in full, raise the probability of more severe credit outcomes for foreign holders of Russian debt securities,” Moody’s Investors Service said in an 8 March statement.
TRENDPOST: Again, we emphasize that sanctions against Russia are, in effect, sanctions against businesses and individuals in the West, raising their costs and costing them returns owed on their investments.
AIRLINE HOPES FALL VICTIM TO WAR IN UKRAINE
As the world’s airlines were gaining passengers and adding routes after the COVID War, another conflict has spiked oil prices and left travelers skittish once again about venturing out into the world.
“We have dealt with pestilence, only to be visited with a war,” Michael O’Leary, CEO of Ireland’s Ryanair, said in a comment quoted by the Financial Times.
“I think it’s going to be very difficult for most airlines for the next twelve months,” he said.
“We’re looking at a delay or interim setback in the airline path to financial recovery” from the estimated $260 billion carriers lost during the COVID era, managing director Philip Baggaley at S&P Global told the FT.
Fuel can make up as much as 35 percent of an airline’s cost and crude oil has reached as high as $139 a barrel, a price not seen since 2014.
Normally, airlines hedge in financial markets against swings in oil prices, however, during the COVID-inspired economic collapse, oil prices cratered along with airline travel, and many carriers stopped the practice.
That has left many exposed now to astronomical fuel costs.
Bargain carrier Wizz Air had not resumed hedging and its stock price lost half its value in the past six weeks, reaching its lowest since late 2020. The airline now has begun hedging again.
Ryanair and British Airways have hedged and are managing with oil prices where they are; the largest U.S. airlines halted the practice because consolidation has given them enough heft to negotiate prices, the FT said.
Only Alaska and Southwest airlines still hedge. The former has protected about half its fuel supply for the year, Southwest 64 percent, the FT reported.
Russia has now banned most major Western airlines from crossing its airspace, which forces flights from Europe to Asia to take much longer routes, burning more fuel.
As a result, Finland’s national airline has ceased flights to Asia. The move erased 20 percent of its market value, sent it into talks with the country’s government for aid, and forced the company to revise both its schedule and its financial plans for the year.
Domestic and short-hop carriers are likely to weather the current crisis best, the FT said, while major international flyers might have a harder future.
“It’s not going to stop Brits going to Málaga this summer,” Davy analyst Stephen Furlong told the FT, “but might Americans not want to go to Berlin?”
TREND FORECAST: As we have noted, these sanctions will do nothing to reverse Moscow’s war direction and will, in effect, only damage the livelihoods of business and individuals.
Just as the decades of sanctions that were imposed on Cuba, Venezuela and Iran by the United States did nothing to change their government, so too will the U.S. sanctions on Russia do nothing to replace those running the country.
And just as with Cuba, Venezuela and Iran, those who will suffer from the sanctions are not those in power, but the powerless people who are pushed into poverty and declining living standards.
WAR SPARKS INFLATION
War and inflation have a long and intimate relationship.
For one thing, war fires inflation in three ways.
First, war places extraordinary demands on military materials—steel, fuel, tires, food—which strains normal production capacities, especially if those capacities have been damaged by bombs or ground attacks.
Second, war disrupts supply chains. Bridges, airports, and rail lines are primary targets for bombing and sabotage; also, as Russia is learning again, allies of warring parties sanction exports and ban imports from opposing countries.
Third, governments pay for wars by printing more money and by keeping interest rates artificially low.
Tamping down the latest spurt of inflation set off by Russia’s war on Ukraine will depend on central banks’ wisdom and skill in orchestrating monetary policy.
Before the 1930s, the value of a currency was usually tied to gold, which kept inflation in check.
During wars, that connection was either suspended or ended completely, leaving the value of money free to soar on the whims of markets.
As a result, hyperinflation—defined as prices rising 50 percent or more in one year—arose in Germany after World War One, in the Soviet Union following the 1917 Bolshevik revolution, and in China during its war with Japan in the 1930s and its internal Communist revolution in 1949.
In the U.S., inflation also has followed war.
European nations sent gold to the U.S. to help fund its efforts in World War One. That raised the money supply and the U.S. Federal Reserve kept interest rates low to keep the economy on keel.
After the war, prices soared and the Fed engineered a quick recession to bring prices back down.
By World War Two, the U.S. had abandoned the gold standard. The government imposed price controls and the Fed enforced low interest rates.
After the war ended and price controls were lifted, prices soared along with demand for materials not only to rebuild but also to create houses, appliances, and the other goods for returning soldiers and their new families.
In the late 1960s and early 1970s, the dual spending demands of the Vietnam war and Lyndon Johnson’s “Great Society” social programs pushed inflation to 7 percent.
Then in 1974, when OPEC imposed an oil embargo on Western nations that had supported Israel during the Yom Kippur War, energy prices soared and inflation did also, reaching 12 percent in that year.
Since then, wars have been regional, not global, making inflation more of a local, rather than global, issue: Russia invaded Afghanistan, the U.S. became mired in Vietnam, a Western alliance sent forces into Iraq.
Now Russia’s invasion of Ukraine has globalized war once again.
The chief inflation victim of that conflict is Russia, where analysts forecast inflation will reach as high as 25 percent this year.
In 2020, Russia was already spending 4.3 percent of its GDP on its military, one of the world’s highest ratios, according to the Stockholm International Peace Research Institute.
In the wake of the Ukraine invasion, Germany has now announced it will increase its defense spending from 1.5 percent of GDP to 2 percent, a 33-percent hike.
The U.S. already spends 3.3 percent of its GDP on defense, The Wall Street Journal reported, but Russia’s aggression in Europe makes “a structural increase in deficit-financed spending more likely in the long term,” according to Jon Lieber, a Eurasia Group analyst, in a note to clients.
The spending bill Congress is now considering would raise military spending by 5.6 percent, he noted.
UKRAINE WAR TRIPLES TANKER RATES
The cost to move oil in tankers by sea has tripled since Russia invaded Ukraine, The Wall Street Journal reported, even though most insurance and shipping companies refuse to handle Russian oil traversing the Black Sea.
Daily rates for the standard mid-size tankers working the Black and Baltic seas has leaped from $10,000 to $30,000 in the last three weeks.
The few companies willing to sail their tankers in those waters can command as much as $200,000 a day, brokers told the WSJ.
However, few are taking the risk.
Because of the war, ship traffic at and around Russian ports has plunged by half, data service Windward reported, and the number of Russian vessels available for charter has tripled since 28 February when the war began.
“Because of the complexity, we will stay away from Russia,” Lars Barstad, CEO of Frontline Management AS, which runs 74 tankers, told the WSJ.
“There’s a lot of money to be made and it’s still legal but very difficult to do in a good manner,” he said.
Tanker rates could move even higher as the world scurries to replace the 2.5 million barrels of oil a day that Russia used to ship, he said.
Since 4 March, at least 12 tankers loaded with Russian oil have been held at European ports by customs authorities, adding extra days to the cost of moving Russia’s crude.
“They’ll hold your ship to see if it has any connection with blacklisted Russian companies,” one unnamed Greek tanker owner told the WSJ. “It’s not worth it.”
WAR LEAVES MERCHANT SHIPS SHORT OF CREWS
Russia and Ukraine together supply 275,000 of the world’s 1.9 million merchant sailors working the industry’s 74,000 ships; Ukraine alone provides 5.4 percent of ships’ officers.
With Ukrainians returning home to take up arms against the Russian invasion, commercial ships are finding it hard to assemble crews.
Ukrainians “are one of the top five [sources of] officers at sea today,” Carl Schou, CEO of Wilhelmsen Ship Management, told the Financial Times.
“Losing this source overnight will lead to strain on overall global crew supply,” he warned.
Of Ukraine’s 80,000 commercial sailors, 55 to 60 percent are now at sea, according to an estimate by the Marine Transport Workers Trade Union of Ukraine, of which about a quarter plan to return home to fight, the union said.
The union has advised them to stay aboard their ships to help keep global supply lines open.
“If most Ukrainian seafarers leave, there’ll be no nationality able to take their positions and this will be catastrophic for world shipping,” union chair Oleg Grygoriuk said to the FT.
The Ukraine conflict is the shipping industry’s second recent obstacle. At one point during the COVID War, 400,000 sailors were quarantined aboard ships, stuck for days waiting to load or unload cargo, or kept at home from working, the FT noted.