How much is sentiment suffering from the Ukraine war?

Since the outbreak of the war in Ukraine, the publication of the PMI for March in the Eurozone is the first important data point for the outlook for the economy. Due to the outbreak of the war, prices for important raw materials such as industrial metals, energy and food have risen sharply. In addition, there is the threat of renewed problems in global supply chains after the war disrupted the land route through Russia and Ukraine for the transport of goods between the EU and China. Renewed lockdowns in China to control an outbreak of Covid-19 pose an additional risk to global supply chains in the short term.

Against this backdrop, we expect a significant decline in sentiment in March, especially in the manufacturing sector. Among service providers, sentiment could stabilize at a high level, given the end of Covid related restriction measures in many countries. The outlook for global commodity prices as well as short-term supply issues should ease somewhat in the event of an early cessation of hostilities. This would help reduce the short-term downside risks to the Eurozone economic outlook.

However, we see two main risk factors that could pose longer-term risks to the economy and inflation. On one hand, the war, like the pandemic before it, has exposed the fragility of global supply chains. Therefore, the trend toward 'deglobalization' of supply chains to increase regional supply security could be exacerbated or accelerated by the war. However, the trend toward globalization has probably made a not insignificant contribution to the gradual decline in global inflation dynamics since the early 2000s. It is possible that a partial reversal of the trend could lead to higher upward pressures in the future, especially for prices of goods.

In addition, Russia is losing access to essential technologies from the US and the EU as a result of the economic sanctions. Due to this loss, Russia's production potential for key raw materials is expected to gradually decline. If Russia's exports of key commodities decline in the long term, this would be a problem for the global economy and could lead to upward pressure on commodity prices until alternatives are found.

US key interest rates to rise faster

The economic impact of the war in Ukraine has made the outlook for the economy considerably harder to assess. What damage will the high energy and commodity prices do and when will the tension ease? How will the supply shortfalls, whether directly from the war or from the sanctions, affect growth and prices?

The impact will certainly also be felt by the US economy. This week, Fed Chairman Powell confirmed that the risks were difficult to assess. At the same time, however, it became clear that the FOMC, the body that decides on monetary policy, sees above all a worsening of the inflation trend. Even before the war, US inflation rates had risen. Overall, this led to a sharp increase in the FOMC members' interest rate forecasts for the next few years compared to December. According to Powell, price pressures will increase for the time being. He said that the inflation peak originally expected for March will be pushed back further.

We are significantly raising our forecasts for US policy rates this year, as rate hikes will come sooner than we had expected. We were already at the lower range of possible developments with our interest rate expectations. However, the US data in recent weeks, the outbreak of war in Ukraine and the latest indications from the FOMC have made our original scenario very unlikely. We now expect a 0.25% rate hike at each of the upcoming FOMC meetings later this year, and as much as 0.5% in May.

In contrast, we continue to expect relatively little movement in 10Y US Treasury yields. We see good reasons why these yields should remain relatively low, compared with the FOMC members' interest rate forecasts of 2.8% at the end of 2023, for example. We believe that the burdens the US economy will continue to face due to the factors mentioned above (energy and commodity prices, supply bottlenecks, general uncertainty) will lead to a slowdown. The market should already be pricing in these risks accordingly. Furthermore, the market assumes that inflation will eventually be brought under control.

The faster rate hikes mean a somewhat slower weakening of the dollar for our EURUSD forecast.

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