Russia's Ukraine invasion has sparked an unprecedented rally in commodities that is likely to keep inflation burning hotter and longer. Post pandemic, inflation has become one of the biggest worries for the economy. Forecasting it accurately in an extraordinary period of uncertainty eluded many economists, and most notably, the Federal Reserve. Now economists say they are working to revise forecasts, but the fast-moving events since Russia's invasion of Ukraine have made the outlook even more uncertain and likely to keep changing. Russia is a commodities powerhouse, and its invasion of Ukraine sent already rising prices for oil, metals and grains even higher. "What we're seeing recently is signs that inflation in March is going to be stronger than we had previously anticipated," said Tom Simons, money market economist at Jefferies. "A lot of the recent increases are in energy and food. We thought we'd hit a rollover period here. February would be the peak and it would moderate into spring but now that appears that it's not going to be the case." Simons forecasts February's U.S. consumer prices will be up 7.8% year over year when the consumer price index is reported Thursday. Instead of falling this month, he now expects headline inflation, which includes energy and food, could rise above 8% year over year. For January, CPI rose 7.5%, the hottest since 1982. Some economists say the Fed fell behind the curve when it held on to the view that inflation would be "transitory," or just temporary, as the pandemic wore on. Now, its view has changed and the central bank is on course to fight high inflation with interest rate hikes, starting this month. So the outlook for higher inflation is double-edged. It will matter to consumers, who have to pay more for food and gasoline, and also businesses who will pay higher raw material costs and higher wages. But the rising cost of money also will matter to investors in financial markets and to anyone looking to borrow to buy a home or start a business. Commodities powerhouse Russia is in a unique position to create its own inflation wave. It is one of the world's biggest producers of oil and gas and is Europe's largest supplier of both those commodities. The U.S., as recently as February, was importing as much as 500,000 barrels a day of Russia's roughly 5 million barrels a day in exports. The country is also the biggest exporter of palladium and this week, the metal was up nearly 22% by Friday morning. Russia is also the largest exporter of wheat, up 40% this week by early Friday. Other commodities have also been rising, like copper, aluminum and corn. The most worrisome source of inflation is oil, and Russia is having a hard time getting its crude sold. That has squeezed global supplies and driven up the price of crude and refined products, like gasoline and diesel fuel. Bren crude was up about 20% in the past week. Sanctions on Moscow's financial system have indirectly affected its ability to sell some of its oil, and that has added to a surge in crude prices. Russian energy has not been sanctioned, but banks, shippers and many customers are worried about running afoul of sanctions and are staying away from it. Brent crude futures, the international benchmark, were at $115 per barrel Friday, the highest since 2008. Economists say oil prices are the biggest and fastest trigger for inflation, given their broad-based economic impact in areas such as transportation, manufacturing and power generation. Oil also is a critical component in plastics, chemicals, building materials and fertilizers. JPMorgan commodities strategists said in a note Thursday that it appears two-thirds of Russia's oil exports are struggling to find buyers. If Russian crude supply continues to be disrupted, they estimate Brent could reach $185 per barrel by the end of the year. Those types of forecasts are uncertain, and economists do not pencil them into their inflation forecasts. Bruce Kasman, JPMorgan's chief economist, said he is calculating crude at its current price, and the inflation forecast has risen several times recently. "Roughly every 10% move up in oil prices is worth something like 0.2 off global growth. Every 10% move in oil is about 0.3 on CPI," he said. Kasman said rising oil initially sparks inflation, but it can become disinflationary. High prices can choke off growth and they reverse if they become so high they lower demand for the product. Kasman said JPMorgan is now forecasting CPI will rise 4.1% year over year in the fourth quarter. "It's been moved about a half point over the last month," he said. He said it's difficult to measure the impact of rising grain prices and metals on inflation. "When you get into the space of food and individual metals, we're more talking about whether it's going to cause a particular supply constraint," he said. Kasman said natural gas has become an issue for Europe. Russia is the major supplier and it had cut back supplies months ago. Both Dutch TTF natural gas futures and British natural gas futures are up 1,000% in the past year and hit record highs this past week. In that same time frame, U.S. natural gas futures rose 77%. Inflation forecasts fluid Kasman expects the forecast to remain more fluid than normal. "There's a whole bunch of things that have surprised us, and are surprising us and we're going to have to roll with the punches," he said. Mark Zandi, chief economist at Moody's Analytics, said he raised his year-end CPI forecast to 5% from 4.5% because of the invasion, but he is not expecting a prolonged spike in oil prices at this point. He said some of the issues in the supply chain that were causing inflation were beginning to ease. But with higher oil prices, the danger is that higher gasoline and other energy prices could have a big impact on the inflation expectations of consumers and investors. "If they keep moving higher here, that would be a signal that we're going to get higher rates of inflation, a more aggressive Fed and the risk of a recession rises for later this year," he said. Barclays economists have also changed their inflation forecast and expect it may have to be changed again. Michael Gapen, Barclays chief U.S. economist, said every time oil makes a big move, he updates his inflation forecast. He has been expecting a year-over-year headline rate of 7.9% for February CPI. He changed the forecast for March, which he now expects to be 8.3% up from a prior forecast of 7.6%. Economists are expecting a natural slowing in the inflation pace in the spring data, That's because inflation was running high a year ago when prices were being compared to a slump in 2020. Gapen said he raised his year-end forecast to 3.8% from 3.4% year over year. "Given recent events, there's more upside risk. We'd been assuming that oil prices would come down and we'd get some deflation in core goods," he said. Barclays chief U.S. economist said he makes a calculation for CPI based on what he sees in the futures market for West Texas Intermediate crude oil and for RBOB gasoline futures contracts, which reflect gasoline prices in New York harbor. He makes his longer term forecasts based on what he sees in the futures curve, meaning the consecutive monthly futures contracts. The whole curve has moved higher, but prices remain lower than the front months further out the curve. For instance, WTI futures at about $111 per barrel Friday, was trading at $105.60 in the June contract and at just $92 per barrel in the December contract. "The market is treating it differently than say a hurricane that hits the Gulf and knocked out production at a couple of refiners for three weeks," he said. "The parallel shift higher means the market is building in some shift higher in prices."
Fuel prices are displayed at gas stations on March 03, 2022 in Chicago, Illinois. Increasing demand and dwindling supplies coupled with global supply uncertainty driven by the war in Ukraine have driven gas prices over $4-per-gallon in many parts of the country.
Scott Olson | Getty Images
Russia's Ukraine invasion has sparked an unprecedented rally in commodities that is likely to keep inflation burning hotter and longer.