What does the Ukraine crisis mean for the US?

Russia’s invasion of Ukraine will have an important impact on the US economic and political outlook this year. 

• The conflict will drive up global commodity prices, fuelling inflation and weighing on US economic growth.

• As a result, we have lowered our forecast for real GDP growth this year, from 3.4% to 3%.

• The US will boost fossil fuel production and cement its standing as a major energy exporter, particularly of liquefied natural gas (LNG), to help to fill demand in Europe.

• Western co-operation, notably on sanctions, has been strong so far. However, we expect cracks in the NATO alliance to appear as the war drags on.

• Closer China-Russia co-operation, with China representing Russia’s sole financial lifeline, will worsen US-China ties even further.

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Risks of stagflation are rising

US trade with Russia and Ukraine is minimal, but the war will fuel already high inflation and slow growth in consumer spending. Even before Russia’s invasion of Ukraine, commodity prices were surging globally owing to four factors: supply-chain disruptions; adverse weather events; new waves of the coronavirus pandemic; and recovering global demand. The further, war-induced rise in global commodities price comes at a time when US inflation is already at a 40-year high (of 7.9% year on year in February). We expect US inflation to remain at current levels (nearly 8% year on year) at least until the middle of the year. This will weigh on consumer spending and real GDP growth. As a result, we have lowered our forecast for US real GDP growth this year from 3.4% to 3%.

No change in sight for the US central bank’s policy

To counter inflation, the Federal Reserve (Fed, the US central bank) lifted its key federal funds rate by 25 basis points on March 16th—the first increase since 2018. The Fed has announced plans for six additional quarter-point rate increases this year, which may be revised up if commodity prices rise faster than expected owing to the war in Ukraine. We expect the Fed to orchestrate a soft landing for the US economy, but the economic fallout from the war and other external factors, such as the emergence of a new variant of covid-19 (which remains our baseline scenario), expose the US to the growing risk of stagflation—low growth combined with high inflation.

The US is sensing an opportunity in the energy field

European countries will turn to the US to help to fill energy gaps as they seek alternative suppliers of oil and gas in a bid to limit their Russian energy imports. The US alone will not be able to fill the current gap created by the expected shift away from Russian energy imports, but the country will still boost domestic production and become an even larger global energy exporter than it currently is (the US is already the world’s fourth-largest crude oil exporter and second-largest natural gas exporter). To meet growing local and international demand, the US will have to accelerate pre-existing plans to increase output, notably in the LNG sector. We estimate that by the end of 2022 the US will have the largest LNG export capacity in the world and will overtake Qatar and Australia in export volumes in 2023, cementing its reputation as a major energy exporter.

The West remains united, for now

A largely unified response by the US and NATO countries has quelled previous claims that Western countries were ineffective in tackling global crises, such as Syria, Libya or Yemen. The high level of collaboration surprised many, especially the Russian and Chinese governments, and has been most visible in the sanctions targeting the Russian economy. The war has also pushed countries—notably Germany—to announce plans to boost military spending to at least 2% of GDP, which has long been a sore spot in US relations with European NATO members.

However, we expect fissures in the Western alliance to emerge as the Ukraine war drags on. Splinters in the relationship appeared only a few days into the war, when the US quickly banned Russian energy imports but the EU did not because of its dependence on Russian energy. European powers are also likely to become more assertive to defend what they think are their own economic interests as they seek greater autonomy from the US in setting their own defence and foreign policymaking. We expect divisions to grow as the war drags on, in line with our long-held view that the global geopolitical landscape is becoming increasingly polarised.

US-China tensions will worsen even further

The war in Ukraine will accelerate the fragmentation of the global geopolitical landscape. Notably, it will further deepen the rift between China and the US. Sanctions and restrictions will lead Russia to lean more on China in the economic, technology and financial spheres. In the long term, we also expect China to pursue greater co-operation with Russia, notably by negotiating for cheaper energy commodities (including natural gas and coal) that Europe is no longer willing to purchase. We also believe that China will be able to serve as Russia’s sole provider of technology components (including semiconductors, although these will primarily be in low- and medium-end chips, where Chinese firms have developed more supply-chain self-sufficiency). This move will be slow, however; Russia currently only makes up 2.4% of China’s trade flows, and the US will threaten to impose secondary sanctions on those Chinese businesses that choose to do business with Russia.

In the geopolitical and military spheres, the war will distract the US from its previous attempts to increase its influence in Asia. We do not expect that the US will be able to maintain a strong trans-Atlantic and trans-Pacific presence. Facing less competition, we believe that China will seek to expand its influence primarily through economic means, such as shaping trade and investment rules with the support of mega-regional trade deals. In contrast, the US will disappoint its Asian partners, such as Japan and Australia, by maintaining a hostile stance towards regional trade agreements that would help to counter China’s influence. In the long term, one Western-bashing bloc (led by China and Russia) and one Western-leaning bloc (led by the US and the EU) will cement themselves into the geopolitical landscape and use economic and military levers to court countries that are not aligned with either side. We expect this competition for influence to expand rapidly beyond Asia and into Africa, the Middle East and Latin America, further accelerating the decoupling of the world’s two largest economies.

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