CITI’S TAKE
The global economy remains in the jaws of a severe supply shock due to the Iran war and the closure of the Strait of Hormuz. Even so, various real-time readings on economic activity point to still-solid performance. These include PMIs, “surprise” indexes, and the performance of global equity markets. The continued momentum reflects in part the accelerating strength of AI spending. But more broadly, the global economy looks to be absorbing the oil shock fairly smoothly. As such, we have marked down our forecast for global growth only moderately. We now see the economy expanding 2.6% this year, down from a projection of 2.9% in February. Bottom line, our forecast remains very much in “wait and see” mode. But to date, the emerging evidence has pointed more toward resilience than to sharp slowing.
Surging oil prices are leaving an imprint on headline inflation—We now see headline inflation rising to 3.5% this year, up almost a full percentage point since the conflict erupted. We are also closely watching the “second round” effects into core inflation, as firms seek to pass through higher costs to consumers. That said, we currently project that the shock will be short-lived, with headline inflation falling back to 2.7% next year.
The cocktail of weaker growth and higher inflation is distasteful for central banks—With the economy’s momentum looking to have remained intact, the markets are increasingly emphasizing the risk of higher inflation and, accordingly, are pricing in less supportive policy paths. The markets now see almost a full hike from the Fed by year-end, three hikes from the ECB, and two or three hikes from the Bank of England. In tandem, long-term interest rates are surging upward as well.
Can growth remain solid if oil prices are stubbornly above $100/barrel?—The jury is still out on this question. The global economy has shown surprising resilience since the onset of the conflict and, more broadly, has shaken off a variety of shocks in recent years. In addition, global inventories are providing a substantial buffer, and oil prices as high as $110/barrel are not unprecedented. From 2011 through the first half of 2014, oil prices ran at similarly high levels and global growth was solid.
Despite the signs of resilience, we remain cautious—These are still early days in terms of global adjustment to the oil shock. If the conflict is not resolved soon, there could be further air pockets and headwinds ahead. One particular concern is that every day that passes with the Strait closed means additional drawing down of global oil inventories. While these stocks strike us as likely to be sufficient for still some time, it’s unclear how low inventory levels can safely go.
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