Market Observations

Between a Rock and a Hard Place

Market Observations Article
March 2022

Authors & Contributors

Chief Economist & Macro Strategist Vincent Reinhart details the difficult path forward for the Federal Reserve in the face of large-scale inflation and shocks to both global aggregate supply and demand amid the Russia invasion of Ukraine.

1.    The Russian invasion of Ukraine poses shocks both to global aggregate supply and aggregate demand. 

  • The supply shock, as it takes key commodities off the market and further impairs already damaged global supply chains, is probably large and long tailed.
  • The demand shock is about lost confidence, income, and wealth. 
  • Central banks are impotent against the former shock, as their actions do not create extra output to fill in lost supply. As for the latter, they can support aggregate demand by making financial conditions easier.

2. The appropriate policy adjustment depends, however, on the joint consequences of the two shocks. A more significant hit to aggregate supply than to aggregate demand adds to cost pressures, posing opposing threats to a central bank’s goals of price stability and maximum employment. 

3.    Russia has marginalized itself on the world economy over three decades, relies on major economies, and is only important among near neighbors. So, the supply effects are mostly about the composition of trade, especially Russian energy output that is almost entirely directed to one place—Europe. 

4.    In addition, Russia and Ukraine are major suppliers of many agricultural commodities, including wheat, corn, and seed oils, which is especially problematic for vulnerable Emerging Market and Developing Economies (EMDEs). Post-pandemic, almost one-third of the global population lives with moderate-to-severe food insecurity. Food and energy price inflation worsens those strains on vulnerable households, as well as the budget position of many EMDEs that provide energy and food subsidies.  The combination foments popular unrest (remember Arab Spring).

5.    This is a further blow to global trade, which had already been set back by the Great Financial Crisis, the subsequent trade wars, and the pandemic. An impaired international market restricts supply and adds to costs.

6.    Inflation is large in scale (near 8 percent in the US), wide in scope (across goods and services in the consumer price index (CPI) basket, some of which have a lot of momentum), and shared by our trading partners globally (two-thirds of which have inflation above 5 percent). The public is worried about the pass-through of rising costs to prices and activity, probably more so than Federal Reserve (Fed) officials. 

  • In current circumstances, the pass-through of rising costs to inflation might be larger than previously because inflation expectations are less well anchored. 
  • As opposed to the prior thirty years, inflation is no longer bound in a narrow range around the Fed’s goal of 2 percent, which had been consistent with the Volcker-Greenspan definition of price stability (when households and firms do not worry about price changes in making decisions). 

7.    If the current adverse shock is more akin to those before the modern era of policy making of the past thirty years, responding to it with modern-era gradualism follows an inappropriate precedent.

  • Having broken out of the Volcker-Greenspan zone of price stability, the current upside surprise of inflation is as dramatic as the downside shocks that previously prompted aggressive easing. 
  • Fed officials should appreciate the need for a significant policy reset in the near term. 
  • True, recession risks are elevated because output effects may be larger from nonlinear effects of recent large changes in oil prices. A pause later as such risks become manifest will at least start from a more appropriate level for the longer run.

8.    Front-loading policy firming now is especially important because the group dynamics of the Federal Open Market Committee (FOMC) will get more complicated. 

  • The current group is not the set of deciders by the end of the year, given the pending changes at two Reserve Banks and three nominations to the Board of Governors (Senate willing). As Chair Powell builds the case for extending the firming cycle at the turn of the year, he will have fewer fellow travelers. 
  • Late in the year, policy will have tightened a bit, financial conditions will have followed up, the unemployment rate will be moving sideways, and inflation will have fallen off its peak. The case for an extended pause will be compelling and shared by many policymakers, but that might make it harder to restart.

9.    We doubt Fed officials sufficiently share these concerns. As a result, our forecast is that Fed tightening will not return inflation to goal within the next two years.


All investments involve risk, including the possible loss of principal. Certain investments have specific or unique risks. No investment strategy or risk management technique can guarantee returns or eliminate risk in any market environment. Past performance is no indication of future performance.

This material has been provided for informational purposes only and should not be construed as investment advice or a recommendation of any particular investment product, strategy, investment manager or account arrangement, and should not serve as a primary basis for investment decisions. Prospective investors should consult a legal, tax or financial professional in order to determine whether any investment product, strategy or service is appropriate for their particular circumstances. This document may not be used for the purpose of an offer or solicitation in any jurisdiction or in any circumstances in which such offer or solicitation is unlawful or not authorized. Views expressed are those of the author stated and do not reflect views of other managers or the firm overall. Views are current as of the date of this publication and subject to change. This information may contain projections or other forward-looking statements regarding future events, targets or expectations, and is only current as of the date indicated. There is no assurance that such events or expectations will be achieved, and actual results may be significantly different from that shown here. The information is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons. References to specific securities, asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be, interpreted as recommendations. Some information contained herein has been obtained from third party sources that are believed to be reliable, but the information has not been independently verified. No part of this material may be reproduced in any form, or referred to in any other publication, without express written permission. 

Indices referred to herein are used for comparative and informational purposes only and have been selected because they are generally considered to be representative of certain markets. Comparisons to indices as benchmarks have limitations because indices have volatility and other material characteristics that may differ from the portfolio, investment or hedge to which they are compared. The providers of the indices referred to herein are not affiliated with Mellon Investments Corporation (MIC), do not endorse, sponsor, sell or promote the investment strategies or products mentioned herein and they make no representation regarding the advisability of investing in the products and strategies described herein.

Recent market risks include pandemic risks related to COVID-19. The effects of COVID-19 have contributed to increased volatility in global markets and will likely affect certain countries, companies, industries and market sectors more dramatically than others. 

BNY Mellon Investment Management is one of the world’s leading investment management organizations encompassing BNY Mellon’s affiliated investment management firms and global distribution companies. BNY Mellon is the corporate brand of The Bank of New York Mellon Corporation and may also be used as a generic term to reference the Corporation as a whole or its various subsidiaries generally. 

Mellon is a division of Mellon Investments Corporation (MIC). Mellon is a global leader in index management dedicated to precision and partnership. MIC is a registered investment advisor and a subsidiary of The Bank of New York Mellon Corporation. 

Dreyfus Cash Investment Strategies (Dreyfus) is a division of BNY Mellon Investment Adviser, Inc. and Mellon Investments Corporation (MIC), each a registered investment adviser. Dreyfus is one of the industry’s leading institutional managers of liquidity solutions. BNY Mellon Investment Adviser, Inc., and MIC are subsidiaries of The Bank of New York Mellon Corporation. 

Personnel of certain of our BNY Mellon affiliates may act as: (i) registered representatives of BNY Mellon Securities Corporation (in its capacity as a registered broker-dealer) to offer securities and certain bank-maintained collective investment funds, (ii) officers of The Bank of New York Mellon (a New York chartered bank) to offer bank-maintained collective investment funds, and (iii) Associated Persons of BNY Mellon Securities Corporation (in its capacity as a registered investment adviser) to offer separately managed accounts managed by BNY Mellon Investment Management firms.