If the War Drags On, Rates Could Rise, Rochester Says

Summary

• Inflation is prioritized over growth for central banks, with ECB and BoE having explicit CPI mandates versus the Fed's dual mandate.
• War-induced oil price increases risk second-round inflation effects beyond energy, impacting polyester, fertilizers, clothing, food, and plastics.
• US economic resilience may lead to underestimated inflation and potential Fed rate hikes, not cuts, especially if the war persists.
• 2022 provides a trading playbook, with current currency and credit market movements mirroring past price action closely.
• Dollar appreciation is expected if the war continues, with Eurodollar potentially declining to 1.12, 1.10, or parity levels over time.
• Key uncertainty is war duration; a quick end would mute effects, but a prolonged conflict exacerbates inflationary pressures and policy responses.
• Inflation expectations are more elevated and volatile now, similar to the 1970s/80s, reducing central banks' tolerance for transitory shocks.
• Terms of trade shock from oil may overwhelm interest rate differentials in currency markets, buffering dollar strength initially.