In 1939, after the Soviets invaded Poland, Winston Churchill told radio audiences, “I cannot forecast to you the action of Russia. It is a riddle wrapped in a mystery inside an enigma; but perhaps there is a key. That key is Russian national interest.”
We find ourselves in a similar position. We cannot predict what Russia will do in the coming days, let alone the coming months. We’re not even sure the key is Russian national interest: Vladimir Putin’s actions in recent years would suggest he is driven by other motives.
We worry, however, that the world looks increasingly vulnerable to a deployment of the country’s long-feared “oil weapon”.
Last year, the legacy of a cheap money-fuelled surge in unconventional energy production and its associated transportation infrastructure helped insulate the US economy against a rise in global prices. Marking a stark contrast with recent decades, the country’s terms of trade actually improved as benchmarks climbed, and ongoing fiscal support meant that households were shielded against some of the distributional consequences associated with higher gasoline costs. The political resolve needed to support the Ukrainian war effort remained largely undaunted, and the oil weapon remained firmly sheathed.
But today, with oil inventories plumbing decade lows, global demand holding up, and the US Strategic Petroleum Reserve partially depleted, major benchmarks are climbing toward the $100 per barrel threshold. At the same time, fiscal support has ebbed, wage gains are slowing, and high interest rates are hitting consumer pocketbooks, raising the psychological impact of rising gasoline prices.
The Ukraine-supportive President Biden is facing a tough reelection campaign, and his odds could worsen if prices at the pump move higher. In contrast, hard-right Republicans – who stand to benefit as the middle class becomes more aggrieved – have turned hostile against sending more aid. Former president – and likely Biden rival – Donald Trump has given mixed signals, hinting at forcing Volodymyr Zelenskyy to forfeit Russian territorial gains in exchange for a peace deal.
Against this backdrop, the strategic logic for widening a wedge in the American political landscape – by cutting off remaining flows to Europe, attacking transportation infrastructure in neighbouring states, and slashing seaborne crude shipments to global markets – might grow more powerful in the months ahead as the war bogs down and the weather turns colder. The global economy could take a serious hit as growth slows, and renewed inflation pressures might force central banks into maintaining rates near current levels, delivering another extreme shock to currency markets.
We cannot forecast to you the action of Russia, yet as another politician – this time, the ancient Greek Pericles – once put it: “The key is not to predict the future but to prepare for it”.
Hedging, particularly using “tail risk” strategies that protect against the most extreme and unforeseen moves in exchange rates, looks prudent at this juncture.