- As we already know, the Russian invasion is sending shock waves through the global economy. There are three ways to study this issue: de-escalation, continued conflict, and escalation. Many believe we are in a "continued conflict" scenario; however, the financial markets are pricing in the "de-escalation" scenario. For the US, the impact of global pressures stemming from this conflict is smaller. Weaker exports to Europe and tighter financial conditions drag on our growth; however, the EU is very dependent on Russian oil. I feel Russia will continue to use this as a bargaining chip. Many think that if the continued conflict or escalation scenarios continue or present themselves, the US will face a GDP hit of .5 to 9, respectively.
- As to the point above, many analysts see crude at $120 a barrel under the continued conflict. Under the escalation scenario, crude could go back to $150 quickly, and there would be a significant risk-off shot in the financial markets. I suspect we will be in the "continued conflict" as mentioned, and markets will sadly grow “numb” to this war until something significantly changes.
- The debate continues whether the FED is behind the curve to curb inflation and, if so, by how much. One view is fueled by the observation that the policy rate is barely off the floor while inflation gallops at the fastest pace in 40 years. Central to this view Is the hypothesis that inflation will arguably recede on its own, and the FED will not have to crush the economy to bring inflation under control. Private forecasters and econometric models based on data from the past 30 years largely agree with this view. If this hypothesis is correct, the FED will have to raise the Fund's Rate to its long-run neutral level over the next year or two and begin running down its asset portfolio, but not much more.
- Responding to FED communications, among other factors, financial conditions have already tightened significantly over the past year. They are approximately as tight now as they were several years before COVID. No one knows what view will be correct; if inflation persists, the FED will have to do more. The FED gave a key message yesterday; they will do what it takes to bring inflation under control; many, including me, are looking for a 50bps move at the next meeting. Should this be the case, many believe bond prices are already reflecting this move.
- Several forecasters remain reasonably optimistic about inflation even though they do not expect the FED to raise rates drastically. Last week, the consensus of FOMC participants was that the FED Funds rate in 2023 and 2024 will top out at about 2.75%, slightly above its longer-run neutral level. I suspect this will be the case while the CPI index starts to move down over the next year.
- Nuveen indicates that HY MUNI's and HG MUNI's seem cheap at these levels. Nuveen made comments yesterday specifically regarding the HY funds they manage; buyers are slowly coming into this market, taking a cautious approach as selling pressure could continue into April.
- BOA indicated last week that they expect the bearish action relating to mutual fund outflows for MUNIs to be confined to the first Q of 2022. Their note indicated that the current outflows from funds should be like what was seen in 2018 when the FED was completing its last cycle of hikes.
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