Israel
The war in Ukraine – a fog battle also on the economic consequences. Continued sanctions on Russia, and a surge in energy prices are expected to lead to a significant slowdown in the world economy, which will eventually affect Israel as well. Israel does not have a large exposure in foreign trade activities to Russia and Ukraine – exports to these countries constitute about 1.6% of Israel’s total exports of goods and imports about half a percent of total imports of goods. Israeli technology companies are active in Ukraine, but they can probably divert their activity to neighboring countries. The indirect effects are significant – the rise in energy prices in Europe and the boycott of Russia will hurt the investment and purchasing power of European countries, which is Israel’s main trading partner. Israel is also in this crisis in a good position in relation to most of the world – the lack of dependence on the global natural gas market, gives local industry a great advantage over competitors, and the damage to the public purchasing power is moderate compared to most countries.
The war has inflationary effects in the short term, but possibly beyond. We are updating the inflation forecast for the coming year to a rate of 2.5%. Most of the update in the coming months, and is due to the rise in oil prices to a level of about $ 100 per barrel. We assume that towards the summer, oil prices will fall slightly, but will remain above $ 90. The price of fuel in March rose by about 5%. We are also seeing an increase in the prices of agricultural goods and especially in the prices of wheat, which have risen by about ten percent since the beginning of the year. Rising energy prices in Europe are expected to continue to raise import prices, as well as maintain high transport prices. A local factor that is expected to have an impact in the short term is the easing of the policy of leaving the country, which will lead to a sharp rise in the prices of travel abroad in March and April.
Despite the decline in the unemployment rate to 3.7% in January, the number of job vacancies continues to rise and has reached 146,000 people. The return of most health workers has not reduced job vacancies, and most jobs are in the services sector. Pressures to raise wages are likely to continue, and in contrast to rising fuel prices for example, this factor has the potential to keep inflation high for longer.
Inflation expectations have risen to all ranges. The bond market now embodies inflation at a rate of 3.3% per year for the next two years. This rate decreases to a level of about 2.5% over a period of ten years. In the derivatives market, one-year inflation stood at 2.8% on Friday. Although price increases are mostly due to global factors that can be interpreted as temporary, the risk of longer-term inflation has also risen, given the likelihood that a process of wage adjustments will be seen, which will leave inflation high.
Will the war curb interest rate hikes? We estimate that the US Fed does not have many degrees of freedom at current inflation levels, and the process of raising interest rates will continue. This can affect the route of interest rate increases in about a year, so the curves are also flat. In Israel, although the degrees of freedom are greater, annual inflation is expected to reach a level of about 3.5% in March, and we estimate that the Bank of Israel will prefer not to delay or increase the financial risks. We expect two interest rate hikes this year to a level of about 0.5% at the end of the year. The derivatives market embodies rapid interest rate hikes to a level of about 1.5% in 12 months.
global
The war in Ukraine created a wide range of economic scenarios, from negotiations and a quick end, to a long entanglement, and a return to a cold war between the blocs. The mood is now shaking the markets, and these will remain volatile until the political picture becomes clear. It is doubtful if anyone would have estimated that given the Russian invasion of Ukraine the global stock index would close a week with almost no change in price. Even the claim that market pricing has already included such a scenario does not hold water, as most analysts have not given it a high chance. In retrospect this may be one of those cases where the stock markets do not necessarily represent the changes in the macro state of the economies, and the timing of the war, after a period of realizations was successful for the stock markets. The fact that Russia and Ukraine together make up only about 2% of world GDP in current dollars may also have helped here.
Russia’s invasion of Ukraine initially led to sharp declines in the financial markets, but towards the end of the trading week ended in a more relaxed atmosphere. The volatility index, the VIX, rose from 28 points to 37 points on Thursday, but moderated again to 28 points over the weekend. Even at the price of a Brent oil barrel, similar volatility was recorded. The price rose during trading on Thursday to almost $ 106 and ended the week at $ 98 a barrel. Equity indices recorded similar declines, bond spreads opened, and demand for government bonds rose.
In the weekly summary, the global stock index fell 0.7% and US stock indices ended in positive territory. In contrast, stock indices in Europe and Asia recorded weekly declines. The German stock index led the declines with a decline of 3.2%, and the stock indices in Italy and France fell at rates of a little less than 3%. Of course, the Moscow Stock Exchange was very much affected by the developments, and the stock index fell by 27%. In Asia, the bulk of the declines were in Hong Kong, where Hang-sang declined 6.4%, followed by indices in India and Taiwan which recorded declines of just over 3%. Commodity prices, especially in the energy and agriculture industries, rose sharply towards last Thursday, but here too there is a correction and / or moderation towards the end of the week. In the weekly bond market summary, the yield to maturity on two-year US government bonds rose from 1.47% to 1.58%, and the ten-year yield rose from 1.93% to 1.97%. Five-year capital market inflation expectations rose from 2.86% to 3.11% and inflation expectations for ten years rose from 2.41% to 2.56%.
Possible economic effects against the background of the crisis in Eastern Europe. At this stage it is clear that this is a “negative supply shock”, which will lead to an acceleration in inflation and may lead to a slowdown in world growth, but it is still too early to quantify the effects. Some of the global effects will be affected by the sanctions and other measures that Western countries will take against Russia. There is great uncertainty about the price of oil in the coming months. Most growth and inflation forecasts before the crisis assumed that the average price of a Brent barrel this year would be between $ 70 and $ 80. Today, some analysts point to $ 100 and $ 120 a barrel as possible during the year. A similar phenomenon exists with regard to the price of natural gas, which is especially important for European countries, especially Germany. Russia’s economy accounts for about 1.93% of world GDP and Ukraine only about 0.18% of world GDP. Despite their relatively low share of global output, they have a significant share in exports of wheat and other grains. Therefore, disruptions in exports may also, like rising energy prices, accelerate inflation and slow growth.
US: Private consumption surprised in January, but consumer confidence continues to fall. Private expenditure rose 2.1% in January, higher than expected, and private income remained unchanged, compared with an expected decline of 0.3%. Even in order for durable goods, there was a sharper-than-expected increase in January, and without vehicles they rose by 0.7%. The increase in consumption was made possible, among other things, by a decrease in the rate of private savings. The rate of private savings from disposable income, which skyrocketed during the Corona crisis, fell to 6.4% in January 2022, lower than before the Corona crisis before the Corona crisis. It fell in February, joining the continuing decline in the University of Michigan’s consumer confidence index, which has fallen to its lowest level in February in recent years. The annual inflation rate in January, according to the Core PCE, was not surprising and rose to 5.1%, the highest rate since 1983, a figure that supports the process of raising interest rates by the central bank.
Will the crisis affect the expected Fed policy? The prevailing assessment is that the acceleration in the inflation environment leaves no alternatives for the Fed, but to begin the process of a gradual increase in interest rates starting with the forthcoming decision in mid-March. The markets now embody about six interest rate hikes in the coming year. Expectations of interest rate hikes do not permeate long-term, meaning markets estimate that the economy will not be able to accommodate sustained interest rate hikes.
Eurozone: Fear of a continuous rise in the price of natural gas. Russia has previously supplied about 22% of Europe’s natural gas consumption. Substitutes for natural gas are considerably expensive. Rising energy prices could have a sharp moderating effect on economic activity in the eurozone. The halting of the “Nord Stream 2” project for the construction of a direct gas pipeline from Russia by Germany could exacerbate the above risk, at least in the short term.
China: Contrary to many estimates, the central bank this month left unchanged prime interest rates on one-year and five-year loans. Apartment prices rose at an annual rate of 2.3% in January, the lowest annual increase since the end of 2015. Most large real estate developers reported declines in sales in January, which in itself exacerbates the situation of companies in the industry, which is mired in high debt and insolvency problems.