Figure 1: Heightened default concerns and a big interest rate response in Russia

The conflict in Ukraine has so far generated a number of predictable responses in financial markets. Aside from a steep plunge in Russia’s ruble and a hike in interest rates to 20% by the central bank, CDS spreads have widened sharply as default risks have escalated. Recent downgrades from credit rating agencies certainly suggest a high probability of a debt default in the period ahead. And the impact of all this on trade, capital flows and confidence is likely to deliver a huge blow to Russia’s economy in the weeks ahead.

As for the impact on the rest of the world the price of oil arguably holds the key. Rising energy prices could lead to stronger price increases in other commodity markets and drive up prices in the food and transportation sector as well, magnifying already intense inflationary pressures.

What will matter for central banks, though, is whether these higher prices generate second-round consequences for wages and for inflation expectations. That seems doubtful, however. Energy prices, after all, are being driven higher by a negative supply shock, not by an overheating world economy. Indeed weaker confidence, financial market instability together with ebbing purchasing power might instead deal a big blow to global growth in the coming weeks. That gauges of market-based inflation expectations have been fairly well-behaved in recent days would suggest that so far investors tend to agree.

Figure 2: Oil prices versus market-based US inflation expectations

Viewpoint commentaries are the opinions of the author and do not reflect the views of Haver Analytics.