Economic webcast

Our monthly economic webcast for December is now available: “A pinch of economic resilience.”

Pandemic developments

The pandemic continues to transition from the BA.5 sub-variant to the BQ family of sub-variants (BQ.1 and BQ.1.1). In the U.S., the BQ variants now represent 63% of all new cases and are still rising (see next chart).

BQ.1 and BQ1.1 are now the dominant variants

As of 12/03/2022. Sublineages of BA.4 and BA.5 are aggregated to BA.4 and BA.5 respectively. Source: Centers for Disease Control and Prevention, RBC GAM

Surprisingly, global COVID-19 infections have remained low even as the new variants have taken over (see next chart). However, there are now hints of infections rising in countries including the U.S., Japan, Vietnam, France, Italy and China.

Global COVID-19 cases and deaths remain low overall

As of 12/04/2022. Source: Our World in Data, Macrobond, RBC GAM

Between the new variants, hints of rising infections and the onset of winter in the Northern Hemisphere, it is increasingly prudent to expect a pandemic wave of some significance over the coming months. Of course, most countries are no longer in the business of locking down. Therefore the economic significance from this is set to be fairly small. It will be measured mainly in workplace absences due to illness and slightly more cautious consumer spending behavior.

Chinese outbreak

China remains the exception to the global pandemic trend. It is suffering a large (by its standards) COVID-19 outbreak, with approximately 35,000 new infections per day on a 7-day moving average basis. Versus other countries, this is a low rate of infection per capita. Nevertheless, it is extremely high for China given a zero-tolerance policy that had kept the virus mostly pinned down over the past three years.

It is hard to compare the latest wave to China’s original bout with the virus in early 2020 given that asymptomatic cases were not monitored then. However, this is at a minimum the biggest outbreak since then, and by some measures even larger than the original outbreak (see next chart). Hospitalizations have nearly quadrupled in the past month.

COVID-19 cases and deaths in China remain high

As of 12/04/2022. Source: Johns Hopkins University, Macrobond, RBC GAM

The Chinese economy is suffering as the country again locks down. Subway ridership is now lower than it was at the worst moment during the Shanghai lockdown (see next chart). Each new variant is more contagious than the last, making each wave more difficult to contain for a country with little natural immunity and without a bivalent vaccine. For the moment, China’s infection rate appears to be stabilizing in response to recent efforts, but not yet declining.

Subway traffic drops in major Chinese cities

As of 12/01/2022. Index is the weighted 7-day rolling sum of subway trips in Beijing, Chengdu, Chongqing, Guangzhou, Nanjing, Shanghai, Suzhou, Wuhan, Xi’an and Zhengzhou. Source: Chinese metro agencies, Macrobond, RBC GAM

Complicating matters, the Chinese public is now reaching a breaking point after three years of heavy restrictions. Recent public protests are the most intense in decades.

There are no easy solutions from here. Remaining locked down would continue to damage the economy for the foreseeable future and raise further discontent.

Conversely, suddenly abandoning the zero-tolerance policy would yield highly unpalatable health outcomes. Modelling from The Economist magazine argues that, if the virus were to spread without restrictions, Chinese infections would peak at an unfathomable 45 million new cases per day, the need for intensive-care beds would be seven times higher than capacity and 680,000 people would die. This would also be politically unacceptable: President Xi is closely associated with China’s pandemic strategy and the country has long bragged of its superior approach relative to the west.

That only leaves one option, and it is the one China is pursuing. The country is seeking to ease some of its harsher (and less effective) rules without losing control of the virus altogether. In a best-case scenario, this will:

• Satisfy protestors.
• Allow the economy a little more room to breathe.
• Limit the virus (or at least allows for the gradual, controlled achievement of herd immunity versus an explosive outbreak).
• Buy time for the delivery of bivalent vaccines over the winter such that a complete re-opening is possible next spring.

Financial markets have been excited by the recent easing of restrictions. There have been several aspects to this. The national government criticized local governments for their overly aggressive pandemic containment policies, meaning that some general slackening is likely even in situations for which the official rules have not changed. Additionally, several cities are experimenting with specific rule tweaks. These include:

• Reducing use of centralized quarantine facilities by allowing pregnant women, the elderly and close contacts of infected people to isolate at home. Beijing is even experimenting with allowing those infected by COVID-19 to quarantine at home.
• Lifting some movement restrictions in Guangzhou after particularly intense protests there.
• Reducing PCR testing – in some cases switching to simpler, cheaper and home-administered antigen tests, and in some cases simply reducing the number of situations in which a test is required. For example, Shenzhen and Shanghai are now allowing commuters to travel via public transportation without PCR test paperwork.
• A new push to get the elderly vaccinated, including a reduction of the minimum waiting time between boosters.

This clearly isn’t a complete abandonment of COVID-19 restrictions. Plenty of people will still find themselves quarantining. Many others will be reluctant to circulate given the risk of being flagged as a close contact, let alone the elevated risk of infection compared to the past three years. But several of the changes should incrementally reduce the bindings restraining the Chinese economy.

Another easy win would be for China to begin importing western bivalent vaccines given that its own vaccines have underwhelmed so far. The country is reportedly in discussions with manufacturers, but has not yet taken action.

Chinese economic suffering

 Chinese GDP in the third quarter was merely up by 3.9% over the prior year, and is set to stumble in the fourth quarter given lockdowns. This is an accurate reflection of the overall growth rate of the country. However, some prominent parts of the country have badly underperformed that national figure:

• Shanghai’s economy is 1.4% smaller than a year ago – a vanishingly rare occurrence for the country’s biggest and most dynamic city. True, the city locked down in the second quarter, but many months have since passed.
• The tourism-heavy region of Hainan is 0.5% smaller than last year.
• The Beijing economy is merely 0.8% larger than a year ago.

These would be poor outcomes in the developed world, let alone in the jewels of a country that was up until recently the world’s fastest growing.

The Chinese labour market has classically been difficult to measure. Many workers are not in the formal economy and the national urban unemployment rate never seems to vary much beyond 5-6% regardless of economic conditions (see next chart). Some of this may represent migrant workers flowing into and out of cities as the demand for workers varies (though official estimates of the number of migrant workers don’t show large swings). Some may also represent China’s habit of massaging its economic data.

China’s unemployment rate rises

As of October 2022. Source: China National Bureau of Statistics (NBS), Macrobond, RBC GAM

The unemployment rate at present is officially slightly higher than normal at 5.5%. The real concern in China’s labour market is the youth unemployment rate. This has long been high despite the relatively small number of young people graduating into the workforce. It has lately soared to the realm of 18—20%.

Chinese consumer confidence has absolutely cratered in recent months (see next chart). This is mainly due to pandemic restrictions, but also presumably in part to elevated unemployment. One imagines it can rebound somewhat as pandemic restrictions start to ease. However, this is unlikely to be a time when Chinese consumers are spending enthusiastically.

Chinese consumer sentiment has nose-dived since Shanghai lockdown

As of September 2022. Source: China National Bureau Statistics, Macrobond, RBC GAM

In turn, Chinese retail sales are now lower than a year ago – quite a development for a country that normally enjoys spending growth of 5—10% per year (see next chart).

Chinese consumer sectors beaten down by zero-COVID

As of October 2022. Source: China National Bureau Statistics, Macrobond, RBC GAM

Chinese exports surged during the pandemic as the rest of the world feasted on goods. However, global consumer demand is simultaneously weakening and pivoting back toward services, at the expense of Chinese exports. Exports have lately declined outright and have further room to ease if they are to return to the pre-pandemic trend (see next chart). If converted to U.S. dollars, Chinese exports are down over the past year.

Chinese exports rise as consumers spend more on goods during lockdowns

As of October 2022. Shaded area represents U.S. recession. Source: China General Administration of Customs, Have Analytics, RBC GAM

Following a government edict that “homes are for living in, not speculation” paired with policies to slow the housing market, the country’s housing market has softened. Home prices are now down on a year-over-year basis and home sales are sharply lower (see next chart).

China’s property sector hit hard by government crackdown

As of October 2022. Home price change is an average of price changes in primary and secondary markets. Source: China National Bureau of Statistics, Macrobond, RBC GAM

In the credit space, China’s credit impulse has again turned negative – a classic predictor of slower economic growth ahead (see next chart).

Chinese credit impulse turned negative amid Zero-COVID and property crisis

As of October 2022. Measured as year-over-year change of 3-month rolling average of sum of total social financing excluding equities and local government bond issuance as % of GDP. Source: Haver Analytics, RBC GAM

Government response

So what is the Chinese government doing about all of this economic weakness?

The country is one of the few in the world delivering rate cuts rather than hikes. Explaining this divergence, inflation is not a problem in China and growth most certainly is.

Zero-tolerance pandemic policies are beginning to ease, as discussed earlier.

Housing market policies are now being altered with the goal of stabilizing the housing market. Some of these are fairly concrete:

• Lenders are to roll over maturing loans to (potentially illiquid and even insolvent) builders.
• Lenders are allowed to temporarily maintain a higher-than normal concentration of real estate loans on their books.

Other housing market tweaks are harder to quantify. They include:

• providing particular help to first-time home buyers
• making special loans to accelerate the delivery of pre-sold homes for which construction has been delayed
• supporting mergers and acquisitions in the real estate space so that distressed companies can be acquired by healthy companies.

It is difficult to say what magnitude of effect the policies will have. Most of them represent edicts from the government as to how lenders should behave, rather than the alteration of laws or the provision of funds to directly finance such aspirations. Perhaps the most useful way to think about the changes is that the purpose is to stabilize builders and the housing industry rather than to supercharge housing again.

How to balance out the bad economic data versus supportive policy? The economy arguably can’t get much worse. Pandemic and housing policies were the ones most in need of attention. As such, there is now probably more upside than downside risk remaining for China – as sniffed out by rallying Chinese equities (off of extremely low valuations). Chinese growth will likely be in the realm of 3% for 2022 and then 4% in 2023 as pandemic restrictions presumably ease and some of these policy measures take hold. But the era of 6%-plus growth is likely long gone.

Economic goulash

Recent data

The U.S. payroll survey for November yielded yet another surprisingly robust month of job creation. The survey revealed 263,000 net new workers and an unemployment rate that held steady at a low 3.7%. The composition of the hiring was slightly underwhelming to the extent it skewed toward economically inelastic sectors like government and health care versus job losses in retail and transportation & warehousing.

At the risk of quibbling, we continue to believe the U.S. labour market isn’t quite as strong as it looks. Case in point, the less closely watched household employment survey argues that U.S. employment instead fell in November (see next chart). This survey has been weaker than the payroll survey in seven of the last eight months, with four months of outright job losses over that span.

U.S. employment may be weaker than it looks

As of November 2022. Source: U.S. Bureau of Labor Statistics, Macrobond, RBC GAM

U.S. job cuts have also surged, suggesting hiring could soon be hard pressed to keep pace (see next chart).

U.S. job cut announcements have picked up speed

As of November 2022. Source: Challenger, Gray & Christmas, Inc., Macrobond, RBC GAM

A softening U.S. economy is more visible outside of the job market. For instance, the Manufacturing Purchasing Managers’ Index (PMI) has now descended to a reading of 49.0, below the critical 50 threshold that separates growth in the sector from contraction (see next chart). This is still somewhat higher than the point at which an economy-wide recession usually transpires (around 43). However, the downward trend is relentless and so such levels could be achieved in the coming months. The new orders component fell to just 47.2, with the employment component down to 48.4, suggesting mild job losses.

U.S. manufacturing activities are deteriorating

As of November 2022. Shaded area represents recession. Source: ISM, Haver Analyics, RBC GAM

In contrast, the Institute for Supply Management Services PMI defied expectations, rising outright from 54.4 to 56.5 in November. The U.S. economy is most certainly not in a recession just yet. The economic data continues to rattle around in all directions.

Meanwhile, in Canada, modest job creation of 10,000 new positions in November understated the true strength of the report. A whopping 51,000 new full-time workers were added. At the same time, monthly GDP growth in September was reported at a modest +0.1%, with October now tracking a flat outcome – not recessionary, but close.

In the Eurozone, the S&P Eurozone Composite PMI edged higher from 47.3 to a still meagre 47.8 – consistent with a private sector contraction in output. Elsewhere, September retail sales fell 1.8% as high natural gas costs in Europe redirected funds from retail spending.

Tempering recession fears

We continue to anticipate a recession. However, the probability may be starting to inch below the 80% likelihood we have long assigned to it given stubbornly resilient economic activity. If a recession does happen, it could be both more useful than usual, and also feel milder than it really is. That doesn’t mean a recession wouldn’t be problematic, but these observations could temper the blow.

A “useful” recession

A near-term recession could be useful in three main ways:

1. Weaker demand helps to reduce inflation. Fixing inflation is the most important thing right now. Setting inflation on the right course promises years of rising prosperity to come, whereas the pain of a recession only lasts a few quarters.
2. A recession should help to further ease housing excesses. Despite the fact that lower home prices are painful for individual home owners, it represents a societal gain to the extent it draws affordability closer to historically normal levels and allows future generations to enter the market.
3. The economy arguably cannot remain in its present overheated state. Demand is excessive in certain sectors and the labour market is unsustainably hot. A decline is inevitable. Less damage occurs if it happens sooner rather than later.

A mild-feeling recession

Technically, we forecast a moderate recession. But it could feel rather milder for several reasons:

• The last two recessions were deeper than what we expect for this one. As such, the recession could feel mild even if it is technically of a moderate depth relative to the longer-term historical average.
• While economic output is likely to fall, we expect less than proportionate job losses. Companies are hoarding labour after several years of struggling to hire. Much of the pain of a recession comes from job losses that create a cascade of problems including people defaulting on debt and scaling back their spending. Some of that may be avoided this time.
• Unusually, even as real Gross Domestic Product (GDP) declines, nominal GDP should continue to grow given the buffer of elevated inflation (see next chart). That is to say, the quantity of things produced should decline, but the amount paid for them and earned from them shouldn’t. Nominal wages, corporate earnings and government revenues may not fall as far as in a normal recession. Much of the benefit from this is psychological rather than real. However, it could still mute the negative response from economic actors or financial markets.

U.S. nominal GDP to continue to grow even when real GDP shrinks

Actual GDP as of Q3 2022, RBC GAM forecast as of 11/23/2022. Shaded area represents recession. Source: BEA, BLS, Macrobond, RBC GAM

Tempering employment hopes

At the same time, it is now necessary to dampen hopes that job losses might be avoided altogether in a recession. There are several reasons why.

The standard – and entirely correct – argument is that it is too optimistic by half to think that the labour market can be downsized purely via fewer job openings as opposed to outright job losses. Historically, both happen hand in hand.

True, job openings are much higher than normal. There is an unusual amount of space for companies to reduce their expansion plans before they have to retreat to contraction. But it is not quite so neat and tidy as that.

For instance, Indeed job data finds that a disproportionate number of openings are in the tech and hospitality & leisure sectors. If economic conditions worsen across the board, those sectors might be able to rely disproportionately on less hiring instead of more firing. However, most other sectors will be pushed into layoffs more quickly. For that matter, the tech sector has hardly been disinclined to lay people off recently despite its large number of job openings.

Even if companies primarily adjust via fewer job openings, those represent workers who would have obtained a job in several months but now won’t. The damage isn’t quite as apparent as when someone loses an existing job, but it isn’t nil.

Job openings could fall more sharply and more quickly than generally imagined. This would necessitate a quick pivot toward layoffs. Many job openings are only notional: companies realize it is hard to find workers and that existing employees will occasionally quit, and so they maintain a range of open postings at all times, whether they truly need someone at that moment or not. The cost to the company is low in this digital age. If someone good comes along or an existing worker leaves, someone might actually be hired. If not, they won’t. This practice is artificially inflating the number of job openings.

As job openings fall, that reduces the bargaining power of existing workers even if there aren’t significant layoffs. That represents a hit to wages and consumption.

So far, layoffs have been disproportionately from the tech sector, with some also occurring in financial services. These are skilled, highly paid industries. Each job loss has an outsized effect in the form of lost wages and consumption. There is no certainty that this pattern of losses persists, but it could to the extent that less skilled workers have been in particularly high demand.

Finally, companies have recently been hiring significant numbers of workers without managing to boost their production to the same extent. As a result, U.S. productivity has actually fallen outright in 2022. Unless production suddenly surges or productivity remains permanently lower, companies may have to shed workers later. Both of these scenarios seem unlikely, although it is fair to concede that the productivity level was exceptionally high earlier in the pandemic.

Growth forecast adjustments

Our growth forecasts are mostly lower relative to a quarter ago. But that isn’t the whole story. We sometimes tweak the numbers we use internally within a single quarter. That’s what happened recently.

In the U.S., we had forecast 0.3% growth for 2023 a quarter ago. The new forecast is set to be just -0.4%. But, for a moment, we had penciled in a -0.6% forecast. Recent U.S. economic resilience has since persuaded us to add a few tenths back on.

It is a similar situation in the Eurozone. Our 2023 growth forecast a quarter ago was for -0.5%, whereas it is now -1.1%. But, internally, it spent some time at -1.4% before being revised higher. In this case, natural gas prices in the Eurozone have fallen a bit more than expected and Eurozone natural gas inventory levels have risen more than expected.

To be fair, the bottom line is still that a recession is likely and our forecasts are not only weaker than a quarter ago but also a bit below the consensus.

However, at the considerable risk of flattering ourselves, we were early relative to the market to downgrade the 2022 and 2023 growth outlook. Perhaps this small upward tweak is an early signal that growth upgrades could now become a pattern. Time will tell.

Probing consumer demand

Thanksgiving long-weekend retail sales in the U.S. were broadly better than expected. Adobe Analytics estimates a 4% increase in sales relative to 2021. This fits tidily into the “surprising economic resilience” narrative.

That said, a lingering question remains. Was the enthusiasm for Black Friday offerings a signal of big plans to spend across the holiday season, or simply in response to deep discounts uniquely available during Black Friday? If the latter, those purchases may have simply represented price-sensitive consumers pulling forward their purchases in a way that leaves a lump of coal for retailers across the remainder of December.

While the answer likely lies between the two extremes, our guess is that a fair chunk represents the front-loading of spending. In fact, on an inflation-adjusted basis, retail sales are already only around flat relative to a year ago (see next chart).

U.S. retail sales growth has dropped significantly

Real retail sales as of September 2022, nominal retail sales as of October 2022. Shaded area represents recession. Source: BEA, Macrobond, RBC GAM

Consumers continue to increase their spending in nominal terms, but they are getting less for their money. Furthermore, consumers are slashing their rate of saving in a way that suggests current spending trends are unsustainable. The U.S. personal savings rate has plummeted from a record high to within a hair of the lowest level on record (see next chart). Even though households do have a bit more money stowed away than normal, this smacks of consumers being slow to adjust their appetites down to their means. The spending adjustment should still come.

U.S. personal saving rate approaches record low

As of October 2022. Shaded area represents recession. Source: BEA, Macrobond, RBC GAM

Online spending share

Online spending surged during the worst of the pandemic, initially rising from just 13% of retail spending to 26% and, during a later wave, to a peak of 28% (see next chart).

Share of online spending now in realm of “new normal”

As of 11/05/2022. Total card spending includes total BAC card activity which captures retail sales and services paid with cards. Does not include ACH payments. Online sales defined as purchases made where card is “not present” and hence may include purchases made over the phone. Source: BAC aggregated card transaction data, RBC GAM

Internet retailers imagined that they would get to keep the lion’s share of this windfall as new customers discovered the superiority of their offerings. They scaled their businesses up accordingly.  They now have to scale back those businesses as a large chunk of consumer spending returned to brick and mortar businesses once conditions permitted.

Conversely, the narrative in the media is that brick and mortar businesses have staged a full rebound.

But that isn’t strictly true. Most of the change has been unwound, but online retail spending now sits at 16% of total spending, up from the pre-pandemic 13%. That is an important difference – it means online commerce is nearly a quarter larger than before. This was precisely the end point that we had forecast for online shopping back in the spring of 2021.

A last note: it appears that the online spending share is starting to edge higher again. This makes sense. Online spending has never been a static figure. Notwithstanding recent turmoil, it has been on a gradual upward trend for decades. That pattern is apparently beginning to reassert itself, though it will be years before it comes anywhere near the peak pandemic share.

Inflation update

A few quick thoughts on inflation. The main story, of course, remains that inflation is much too high. However, it is seemingly turning as supply chain bottlenecks ease, commodity prices ebb, monetary restraint is applied and governments spend less money. We look for inflation to decline more quickly than the market imagines – a good thing.

Three new developments appear to support that forecast.

1. Chinese deflation begins

China’s producer price index has now fallen into outright deflation on a year-over-year basis (see next chart). Some of this is a domestic affair that reflects anemic consumer demand within China. But it nevertheless has consequences for the world.

Despite recent geopolitical frictions, China remains manufacturer to the world. When China’s factory prices fall, that surely bodes well for the downstream cost of goods nearly everywhere.

Producer prices in China have been retreating

As of October 2022. Shaded area represents U.S. recession. Source: CNBS, Macrobond, RBC GAM

2. Eurozone inflation turns

North American inflation began to turn lower in July. However, Eurozone and U.K. inflation continued to rise stubbornly, to even higher levels than the peaks experienced in North America. The difference is largely due to the relative softness of the euro and pound (weaker currencies import inflation), plus exposure to skyrocketing natural gas prices as Russia cut off Europe’s supplies.

The good news is that Eurozone inflation finally declined in November, from 10.6% year-over-year to 10.0%. That was a larger decline than expected. A big part of the reason is that natural gas prices have fallen in Europe as inventory levels have swelled (see next chart).

Natural gas prices remain high, but down from their peak

As of 12/01/2022. Source: Intercontinental Exchange, Macrobond, RBC GAM

Promisingly, and consistent with the observation that China’s producer price index is declining, the German producer price index recently fell on a month-over-month basis for the first time in two years. When producer prices are falling, consumer prices cannot be far behind.

The U.K. is still awaiting its first inflation reprieve, but there is a good chance this will happen when the country’s November inflation data is released. The Bank of England’s chief economist has predicted that British inflation will begin to fall within the coming months.

3. Black Friday discounts arrive

We return to the subject of Black Friday, but this time with an eye on the discounts offered by retailers.

When inflation was first building, the story was that it wasn’t so much that companies were raising their prices but that they were ceasing to offer sale pricing. It is thus highly interesting that Black Friday brought generous discounts. Companies are apparently losing their pricing power. This would seem to signal the reversal of another subtle force that drove inflation higher over the past 18 months.

Familiar theme for central banks

It is the same story for central banks. They continue to raise rates (or plan to raise rates), but at a diminishing rate.

The Bank of Canada’s rate decision on Wednesday, December 7 is expected to yield a 25 basis point rate hike (to a 4.00% overnight rate), though a 50 basis point increase is conceivable. This represents a significant deceleration from the earlier rate of tightening. The market is increasingly of the mind that the peak Bank of Canada policy rate will be in the realm of 4.5%.

In the U.S., the next Federal Reserve decision will be rendered on December 14. A 50 basis point increase is likely, though a 75 basis point increase is not quite impossible, especially given recent labour market resilience and the recent easing of financial conditions. The most likely outcome would take the fed funds rate up to 4.25%. The markets currently deem a peak policy rate in the realm of 4.75% likely.

The European Central Bank (ECB) and Bank of England then squeeze their decisions into the next day – December 15. The ECB appears set to lift its policy rate by 50 basis points from 1.5% to 2.0%, though some speculate that a 75 basis point increase is possible. It is a similar story for the Bank of England, with the policy rate expected to rise from 3.0% to 3.5% -- a 50 basis point increase, but with the chance of a 75 basis point increase.

New oil rules

Two significant changes were made to the global oil market on December 5.

1. The European Union (EU) has followed through on a plan announced last summer to ban the import of most oil products via tanker into the EU from Russia. Oil imports into the EU via ship amounted to around 1.5 million barrels per day when Russia invaded Ukraine. That has since fallen to just 309,000 barrels per day over the past four weeks. As such, the incremental hit is fairly small from here for both Russia and the EU, though each has to scramble to find other sources of demand and supply respectively for the remaining amount.
2. More significant, the EU, alongside the G7 and Australia, have now implemented an agreement to force Russian oil exports via tanker to be priced at $60 per barrel or less. Given that the price of Brent oil is in the realm of $85, this sounds like quite a discount. However, in practice, Russia has only been receiving around $65 per barrel given its limited selling options, so the discount is fairly small.

The countries plan to enforce the rule due to their strangle-hold on the shipping insurance industry and associated services. Shipping insurance won’t be provided for oil tankers transiting from Russia unless the buyer has paid no more than $60 per barrel. In turn, non-compliant ships won’t be able to operate.

In theory, this is a way to deprive Russia of oil revenue without depriving the rest of the world of oil (and it saves a bit of money, to boot). The EU, U.S. and Canada don’t stand to save any money themselves as they have already banned ship-based Russian oil from their own shores. But countries like China, India and others could.

In practice, the situation is likely to be quite messy and fluid. The problem is that Russia says it will not transact with any party abiding by the new price cap. If both sides remain firm, more than 3 million barrels of oil per day could suddenly become unavailable, triggering a price spike.

Market participants are now looking for ways to set up ship insurance capabilities outside of the west, allowing them to dodge the price cap. Russia has set up a “shadow fleet” of over 100 tankers that can in theory operate either without insurance or with cobbled-together non-western insurance. China and India will probably find ways to procure Russian oil despite the ban. But the hope is that, at a minimum, the extra bargaining power such countries gain will force Russia to make additional price concessions, further starving the country of capital.

In the short run, one could imagine higher oil prices as a game of musical chairs occurs in which Europe scrambles for new sources of oil, displacing others who must then scramble for Russian oil while trying to navigate the new restrictions. Frictions are already emerging in the form of a backlog of tankers waiting to transit through Turkish waters. Turkey is now insisting that such ships provide proof of their maritime insurance given the new rules.

Over the medium run, aside from scrambling who buys oil from who, it isn’t clear that the oil market will have been enduringly impacted or Russia significantly punished. Reflecting that, OPEC opted to hold steady in its production until the dust settles.

-With contributions from Vivien Lee, Vanessa Adams and Aaron Ma