How Russia’s Invasion Of Ukraine Could Affect Europe And U.S. Economy

The Ukrainian people have demonstrated extraordinary courage in the face of an terrifying threat from Russia. From the first attack February 24, Ukrainians have resisted, and indeed, pushed back on Putin’s persistence to control the region. In Putin’s worldview, Russia must regain its dominance on the world’s stage, even if it means ruthlessly slaughtering mothers, babies, and a host of innocent civilians. Yes, it’s tragic. Another element of Russia’s attempt to take over Ukraine is the economic fallout. Certainly, Russians will feel the brunt of it given the sanctions levied against the country and Ukraine will suffer greatly as well. Europe will also feel economic pain as it relies on Russia to meet its energy needs. Could there be a spillover effect in America? Is a U.S. recession possible? In short, yes, it’s very possible.

Europe’s Energy Plight

According to the U.S. Energy Information Administration, Europe is a key destination for Russia’s energy exports. In 2021, Russia exported 49% of its crude oil and condensates and 74% of its natural gas to Europe. In short, Europe is Russia’s largest energy customer. Most of the Crude went to the Netherlands, Germany, and Poland while the majority of Russia’s natural gas went to Germany, Turkey, Italy, and France. Yes, Europe is very dependent on Russia for its energy and turning that off is no easy task.

Europe derives nearly 25% of its energy from natural gas and canceling the Nord Stream 2 pipeline, which would run between Russia and Germany, would affect its future gas imports. In retaliation, Russia has discussed stopping the flow of natural gas to Europe. Clearly, energy is a chief concern to Europe, one of the world’s most energy dependent regions. As a result, expect the European economy to slow, which could have a negative effect here in the U.S.

United States Fallout

A slowdown in Europe from the war in Ukraine is but one of the factors that will drive U.S. economic growth. Fed policy is another. How will the war affect the U.S. economy?

There are a lot of multinational corporations in the U.S. that derive revenue from Eastern Europe. If Europe’s economy slows, many companies could experience a reduction in revenue. Which companies are most at risk? Here are a few based on revenue (as a percentage of total revenue) derived from the conflict zone. The list includes Philip Morris (8.0%); PepsiCo
PEP
(4.4%); Mohawk Industries
MHK
(4.3%); McDonald’s Corporation (4.2%); and Carnival Corporation (3.6%). There are others, but these are the top five. If Russia continues to wage war on Ukraine, the revenue loss experienced by U.S. companies could send stock prices lower. But there is another serious threat to the U.S. economy. Enter the Federal Reserve.

Fed policy is another key determinant for the U.S. economy. After nearly 14 years of a zero-interest rate policy and two years of extreme monetary stimulus, the Fed has announced an end to both. In its last meeting, the Fed raised its short-term interest rate by 0.25%, marking the first time since the housing crisis it has been greater than zero. With 5-7 additional rate increases to come, plus the removal of the excess monetary stimulus, the Fed is attempting to curb inflation.

Why is inflation so elevated? Inflation occurs whenever demand is materially greater than supply. This time, inflation rose because of Covid related supply chain interruptions and pent-up demand. It is also greatly affected by rising energy costs such as the price of oil, natural gas, and gasoline plus higher prices for food. Ukraine and Russia provide about 25% of the global supply of grains. Grains are used to feed livestock, farm-raised fish, chicken, etc.

In changing from an easy monetary policy to a tightening policy, the Fed will need to be extremely careful that it doesn’t go too far and cause a recession. For example, if the Fed continues to tighten, while supply chain issues and the war are resolved, the U.S. economy may well end up contracting. The Fed can only influence the demand side of the inflation equation so it must watch the supply side very closely. Therefore, if the war in Ukraine concludes, and Covid related supply chain issues are resolved, and the Fed continues to tighten, a recession is a very good possibility. Although most economists don’t expect it until sometime in 2023.

Stay tuned.