In the week ahead, the world’s attention will continue to be focused on the horrific human consequences of the Russian invasion of Ukraine. However, American investors will also be considering what it means for financial assets. While the most severe economic consequences will likely be felt in Europe, the most important effects on U.S. portfolios depend on the implications of Ukraine for the U.S. economy.

Any such assessment needs to start with some assumption on how the conflict could play out.

There are, of course, a multitude of scenarios, some dire and some a little more optimistic. However, probably the single most likely outcome, as of today, is one in which Russia makes further territorial gains in Ukraine but is unable to create any stability with the Ukrainian people and army waging a vigorous guerilla war against the occupiers.

In response, the West would likely gradually escalate its sanctions on Russia. This would inflict economic pain on the Russian people as would the cost of running the war in Ukraine. For the West, however, the single biggest economic impact would be via a partial or total cutoff of Russian energy.

This would be particularly painful for Europe. In 2019, Russian imports accounted for roughly 26% of European oil consumption and 37% of European natural gas consumption. Europe’s natural gas dependence on Russia is particularly problematic because, while oil is a global commodity, natural gas, at least in the short-run, is a regional one. While Europe could import more oil from other countries, for natural gas it is hard to see how it could increase supplies or cut demand enough to avoid a massive price spike.

For European consumers, higher energy costs are already taking a toll. In the absence of significant income support from either national governments or a new European economic stabilization fund, an energy shock could trigger a recession.

For the United States, the situation is less dire. A recession in Europe would have a negative impact on U.S. exports to Europe. However, exports account for less than 11% of U.S. GDP and, as was the case with the Asian financial crisis of the late 1990s or the European debt crisis of the last decade, the U.S. economy has generally been able to weather sharp downturns in other global economies.

That being said, rising oil prices would likely have a significantly negative impact on the U.S. economy. As this is being written, the April contract for West Texas Intermediate Crude has spiked to $123 per barrel as the U.S. and Europe are considering banning imports of Russian Crude. In 2021, the average price of a gallon of gasoline in the United States was $3.09. If oil prices stayed at $123 per barrel for the rest of the year, gasoline would likely average close to $4.20 for the year, adding over $1,000 to the expenses of the average household.

This would not, of course, be the only inflationary impact of the Russian invasion of Ukraine. Extra demand for LNG could keep U.S. natural gas prices somewhat higher than they had been previously while diminished supplies of grains and fertilizer from Ukraine and Russia would boost global food prices. This could well boost CPI inflation to 8.0% year-over-year in March.

Thereafter, a number of factors could help dampen oil prices including greater U.S. shale oil production, greater output from Iran if it rejoins the Iranian nuclear agreement, greater output from other members of OPEC in the face of high prices and a diversion of more Russian crude to China allowing China to reduce its purchases from OPEC nations. High oil prices and a slower-growing global economy would also, of course, reduce the demand for crude.

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