Last week, we discussed the prospect of Russian invasion altering the reaction functions of global central banks, suggesting that the key differentiating factor between the respective reaction functions is the underlying strength of domestic demand - or growth. However, while we maintain the view that underlying consumer growth (excess demand) is a huge factor, there are other implications for monetary policy from the commodity space - as everything from oil and gas to corn and wheat have surged following the escalating conflict in Ukraine - which likely act to further contract consumer incomes, particularly in the majority commodity importing countries.

Many commentators, at least prior to the intensification of the Russia/Ukraine situation, emphasised the EU Recovery and Resilience Fund (RRF) as a factor driving higher eurozone growth relative to the US in 2022. We questioned this at the time, but the current backdrop has likely further shifted the balance back in favour of the US. Indeed, the intensification of energy price rises likely even divert a significant portion of the RRF away from structural productivity improving investment and infrastructure, towards direct support for domestic, and corporate energy cost rises - literally burning the money to keep warm.

On the flip side it is interesting to note The Economist last week, highlighting, in great detail, the extent of US state coffers - still fully loaded from the (Donald Trump and President of the United States) stimulus. Furthermore, China growth continues to be supported by targeted fiscal stimulus. At the local government level in China, we expect a further significant fiscal boost in 2022 - we will find out more in coming days from the Two Sessions announcements, but even if the overall deficit targets remain unchanged from last year, this comes on top of significant funding unspent from last year due to Covid restrictions and, to a lesser extent, property market dislocations.

At the start of the year, it was a popular narrative among commentators that the US fiscal cliff and China slowdown could mean eurozone growth would outperform the US and China in 2022. Unlikely, then. Even more so now!

In short, the growth and inflation backdrop is incredibly complicated at the current juncture, and it is not clear that further inflation through the supply channel will lead to higher rates - especially if there is no excess demand.

This week, we have heard from a number of Central Bank speakers from around the globe adding colour to the debate about central bank reaction functions.

In the UK, we have heard from multiple members of the Monetary Policy Committee (MPC), - where the discussions highlight a more nuanced situation in the UK in many respects. One member of the MPC (arguably the arch hawk on the committee) talked of UK excess demand and the need to anchor inflation expectations, at the same time adding that it is not clear what the implications of the current surge in oil and gas prices will be two-three years out. The other MPC members were more cautionary however, with the latter warning on asset prices and the prospect of weaker growth and the former more explicitly linking her rate hike urgency to wage pressures, amid extreme goods and commodity price volatility.

In the eurozone, the minutes from the January European Central Bank (ECB) were more focussed on the need for policy optionality against both an uncertain inflation backdrop and a wide divergence of opinion on the Governing Council. However, it is clear that the situation regarding energy and food price inflation has become significantly more acute in recent weeks, and we would anticipate the urgency to normalise that was inferred by markets from the January meeting (though we were very clear in our disagreement with the markets belief that two 25bp rate hikes in 2022 were ever possible), will be moderated in March. Indeed, warnings from the ECB Vice President, that the implications of the current situation are both bad for growth and inflation, have stoked concerns of stagflation in some circles.

However, in the US, the situation remains more hawkish. In his semi-annual testimony to congress this week, the Federal Reserve (Fed) Chair (pro tempore) was clear that, while the impact of the Russia situation on the US economy is highly uncertain (somewhat offset by the Treasury Secretary, who said that she did not expect major impact on the US trajectory from the war in Ukraine), the Fed will proceed, albeit carefully, with the plan laid out before the crisis - namely that the Fed will likely support a 25bps hike in March (avoiding adding uncertainty to a difficult situation), that every meeting remains live, and that the aim is to make good progress on the plan to shrink the balance sheet.

The clear differentiator here is the current growth dynamic. Indeed, in Canada this week, the Bank of Canada raised rates 25bps to 0.50%, alongside the narrative that further rate hikes will likely be appropriate. This was followed by commentary from the Governor of the Bank of Canada, who explicitly stated that “the economy can handle higher rates, growth is robust ”!

Furthermore, against the current backdrop, there are further differentiating factors for the growth and inflation trade off through the global trade channel, and whether or not countries are commodity (not just oil and gas, but metals, grains, fertilisers,...) exporters or importers. Recent price movements have therefore had significant positive or negative implications for countries and indeed currencies, through the current account implications.

So while we continue to like the USD on both safe haven as well as wider growth and yield differentials, there is also a case to be made for the outperformance of commodity exporters, such as Australia and Canada in Developed Markets, and for Brazil, Mexico, and a number of others in Emerging Markets.

As far as the situation in Russia is concerned, to paraphrase the opening quote, a reversal of the current situation in the near term seems complicated. We can only hope that the planting of trees comes as soon as possible. Trees of compromise. Trees of peace.