Latest / Look Forward / Middle East Tensions: Global growth, inflation, and risk | Look Forward Ep. 29

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Middle East Tensions: Global growth, inflation, and risk | Look Forward Ep. 29 · Look Forward

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  Hello, and welcome to the Look Forward podcast from S&P Global.
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  I'm Aries Poon from Market Intelligence Division.
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  I'm leading the analysis team for Asia Pacific and Latin America,
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  and I'll be your host today.
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  In today's rapidly shifting markets, success depends on
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  Together, we are committed to providing you the forward-looking
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  intelligence you need to navigate uncertainty with confidence.
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  Today, we are looking at the macroeconomic consequences of the Middle East conflict,
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  how geopolitical disruption shows up in growth, inflation, financial
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  conditions, and central bank decisions.
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  Our guest is Paul Gruenwald, Global Chief Economist from the Ratings Division.
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  Paul, great to have you.
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  Likewise, Aries.
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  Great to be here.
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  So when you zoom out and think about the global economy this year and
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  next year, what would be the single most important macro implication
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  of the Middle East conflict?
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  Well, I think this is another example of, uh, a choke point, or sometimes
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  we frame this as geoeconomics.
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  This is countries using their, um, their, uh, leverage over either
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  physical or financial, uh, choke points on the global economy to kind
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  of get the outcomes, uh, they want.
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  Uh, we saw this with trade, we saw this with, uh, uh, strategic minerals.
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  So it's really another step away from this Washington consensus
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  world of free trade and free capital flows and general openness.
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  So these kinds of choke points make the world more risky, more expensive,
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  and, uh, you know, slower growing, and I think this is the era we're in.
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  And, uh, this, uh, closure of the Strait of Hormuz is just another example
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  of that.
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  Actually, before the conflict escalated, uh, the global outlook
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  looked actually more supportive.
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  So what has changed, and why does the war alter that balance?
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  That's right.
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  When we were, um, uh, getting ready for our first quarter forecast,
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  uh, on my team, we were talking about a number of tailwinds to
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  the global growth story this year.
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  We had the AI, uh, CapEx investment boom centered on the
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  U.S. We had low energy prices.
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  That's obviously not with us anymore.
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  And we had relatively supportive financial conditions, and those have
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  shifted to a more, uh, neutral stance.
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  So we've gone from three potential tailwinds this year, uh, to kinda one
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  and a half, and the way this came out in our forecast that we released last month
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  was we framed it as the, uh, Middle East war shock neutralizing those tailwinds.
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  So we took most of the, uh, uplift to growth, uh, off the table, and
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  now we're characterizing the outlook as one where the downside risks
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  to the baseline now predominate.
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  So let's get more precise on how the shock travels from the real,
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  from the real economy into markets.
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  Um, I've heard you describing the economic impact of the
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  conflict in three stages, right?
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  Flow shock, supply shock, and market shock.
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  And how should our audience think about the different channels through which
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  this conflict hits the global economy?
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  Right.
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  Well, just to be honest, that's not, uh, that was not my characterization.
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  I, I borrowed that from our colleagues at S&P Global Energy.
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  But I found it extremely useful.
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  So as you said, the initial phase of this was a flow shock.
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  That's when the strait was closed, but those initial ships and tankers got out.
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  It took a couple of weeks, up to a month, uh, to get to their, to their destination.
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  So markets were reflecting some turmoil, but the physical part, uh,
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  of the crisis had yet to manifest.
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  Once those ships reached the ports and there were no more ships coming
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  because the strait remains closed, then we're w- we were getting into
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  the supply shock phase of the crisis.
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  That's where we are right now.
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  And there it's really important to look across the, uh, economies, uh, and
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  see which ones are energy producers.
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  They're relatively in good shape.
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  Which ones are energy importers with buffers.
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  We know, for example, that China was, uh, building up its stocks in recent years.
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  Japan and Korea have stocks as well.
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  But there are neve- another… a number of countries in this third group, uh,
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  I would say India, parts of South Asia, Philippines, uh, Egypt, uh, some African
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  countries, that really don't have many buffers at all, and that's where
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  we're seeing, uh, the initial impact.
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  So this is a supply shock, so the physical, you know, quantum of
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  molecules, as our friends in energy like to say, uh, really matters.
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  And that's where we're looking for the stress points right now.
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  We think we're in that second phase still, in that supply, uh, shock
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  phase, but as those buffers start to deteriorate, that's when we're in danger
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  of going to a more dangerous phase.
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  So for business and, uh, financial market decision makers, like what
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  signals would you tell them that pressures are, you know, looking to
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  shift into, say, the market shock phase or a more destabilizing phase?
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  Right.
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  That's, uh, that's the big question, right?
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  We're, we're still in, uh, oil prices around a hundred plus or
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  minus per barrel, so it is definitely higher than it was earlier in the
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  year when we were around sixty.
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  But, uh, in real terms, uh, it's not as bad as, say, where it
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  was in two thousand and eight.
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  Uh, so we're actually looking closely at the, uh, at the, uh, stock dynamics.
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  We know that those stocks can't last forever.
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  We're looking at the, uh, the spot prices, uh, for Brent and others.
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  Those are spiking in places like Oman.
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  But, uh, uh, not entirely clear when we enter that final phase, but that's a phase
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  where markets would reprice the global growth outlook, where the, uh, you know,
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  the supply shock really starts to bite.
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  And then we would get more broad-based macro effects beside or in addition
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  to the, uh, the physical, uh, effects.
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  And then you would get a marking down of growth, probably
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  some equity market stress.
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  You'd get a wealth effect.
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  You get volatility, flight to quality, the usual type of thing, things we see.
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  That's, uh, you know, that's not, uh, out of the realm of possibilities, but
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  we probably have a bit further to go until we get into that, uh, scenario.
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  But the key variable to watch there is these, uh, buffer stocks, uh, that
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  many of the economies are now using to shield their population from the,
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  uh, effects of the Middle East crisis.
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  Yes.
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  And when you talk about buffer stocks, that leads, uh, us naturally to energy
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  because it, it changes the whole inflation versus growth calculus.
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  So how is an energy-driven shock fundamentally different from other types
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  of shocks, say, driven by trade or other policies that we've seen in recent years?
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  And why does that matter for inflation and growth dynamics?
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  Yeah.
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  Well, first of all, this is a supply shock, and we know that supply shocks
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  are different than demand shocks.
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  In a supply shock, uh, prices tend to go up and out-output tends to go down.
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  Uh, that's a problem for central banks.
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  I think we're gonna talk about that, uh, later.
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  But again, this is really about kind of the, the, the molecules, the oil and gas
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  molecules being trapped, uh, in the Gulf.
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  And I think we probably pay insufficient, um, attention to energy flows, uh,
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  when we're thinking about macro.
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  So you mentioned the, uh, you know, the, uh, the tariffs last year, and those are
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  changing relative prices, and we th-- we can think of supply chains adjusting and,
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  you know, production adjusting, et cetera.
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  But, uh, there's really no disruption into a fundamental
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  input, uh, for economic activity.
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  Um, that's what we're seeing right now, and that's why this particular
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  shock is different and much more challenging, uh, for, uh, for firms,
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  businesses, and, and policymakers.
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  And in this kind of environment, how does the burden of energy price rises get
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  distributed across economies and sectors?
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  That is actually a super interesting question because we know the price of
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  energy has risen, but the question is who-- what, what's the incidence of that?
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  It's a little bit like the tariff question we were asking last year.
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  Who's ultimately paying for these higher, uh, oil prices?
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  And we have three, uh, three candidates here.
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  First, the government can absorb the, uh, higher prices and not pass them on to
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  firms and consumers, so that's gonna put pressure obviously on the, uh, you know,
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  the government's balance sheet, and all else equal implies they'll need to issue
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  more debt, uh, to finance their operation.
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  We could also have margin compression.
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  We can imagine a situation where there's a state-owned or state-controlled
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  oil firm, and they are, you know, incentivized or orders to, uh, you
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  know, not increase prices and maybe compress their margins, uh, to lower
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  levels than they would normally be.
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  Or we could pass the, uh, the, uh, higher prices straight on to consumers.
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  We're seeing that, uh, in the US.
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  We're seeing more of the, uh, fiscalization, uh, in Asia and then
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  some intermediate cases in between.
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  But it really helps to, uh, uh, think about where it's showing up in the system.
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  We don't get stuff for free in economics, so it has to show up somewhere between
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  fiscal pressure, margin compression, and, uh, higher prices for, uh,
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  firms and consumers in the end.
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  Great.
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  Um, let's zoom out again a little bit, uh, because I've also heard
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  you describing the global economy as unusually unsynchronized.
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  And how does this conflict amplify those differences across major economies,
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  say, the US, Europe, and China?
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  Right.
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  Well, we like-- That's-- Those are the three economies we typically
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  focus on at the beginning of our forecasting round and when we, when
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  we do our macro, uh, surveillance.
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  Sometimes those macro, uh, stories are more or less aligned.
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  They're very unaligned, uh, right now.
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  I think the energy, uh, shock amplifies this because the US, as we
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  know, is a net, uh, producer and net exporter of energy, so these countries
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  will definitely see some benefit, uh, from the, uh, from the crisis.
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  Uh, the, these are globally traded goods and global prices, so energy
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  costs are going up here in the US.
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  But, uh, you know, firms who produce this are seeing, uh, windfall profits,
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  and the US has been able to export, uh, into higher prices as well.
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  Uh, China, as we mentioned, has been building up buffer
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  stocks over, uh, recent years.
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  They look at least relatively well-insulated, uh, in the
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  short term, and not everything's passing on to final consumers.
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  And, uh, Europe's a little bit of a mix, uh, in between, maybe
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  more exposed to gas, uh, than oil.
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  But, uh, we had a relatively unsynchronized, uh, configuration of
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  global growth going into this, uh, crisis and, um, as you mentioned,
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  Aries, the, uh, the energy shock has actually amplified that.
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  So what does that divergence you talked about imply for, uh, coordination
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  among policymakers or maybe the lack of coordination a-a-among policymakers?
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  Yeah.
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  Well, we did see that, um… we did see the release from the, uh, IEA, the
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  International Energy, uh, Association, for the, um, you know, for the
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  release of, uh, strategic oil stocks.
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  That wasn't very large in the, uh, grand scheme of things, and we see a
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  lot of, uh, self-insurance, uh, again, China, Japan, uh, and, uh, Korea maybe
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  being good, uh, examples of that.
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  So, you know, the coordinating mechanism is actually, uh, the price.
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  We don't have a, you know, an International Monetary Fund for
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  energy that countries can draw on, and, uh, stocks are gonna
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  help us through, uh, all of this.
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  But this is a new shock.
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  You know, the strait has never been closed, uh, before, and, uh, we haven't
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  had something like this since the 1970s.
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  So I think when this is over, uh, we're gonna have some conversations
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  at the international level.
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  I can imagine countries will be building up more of their energy stocks, building
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  more redundancy and cost into the system.
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  But, um, we're a little bit in uncharted waters in terms of global
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  coordination for a physical energy shock, so we will be watching how that
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  plays out, uh, in the coming months
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  Thanks, Paul.
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  And let's close today's session with, uh, with a look at, uh, at, at where
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  the constraints can bite hardest.
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  So we're talking about emerging markets, Asia, and central banks.
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  So overall, where do you see the economic stress accumulating
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  most acutely as this plays out?
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  Yeah, well, as we, uh, as we hinted at earlier, the stress is gonna be
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  energy importing countries that do not have a lot of buffer stocks.
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  So they will be forced to, uh, go into the market and buy at the, uh, at the spot
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  price, which is sometimes significantly higher than what we're seeing in the
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  benchmarks like the Brent, uh, and WTI.
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  If we do not get more supply onto the market, we will have to have
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  what we call demand compression.
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  So if supply cannot rise, uh, because, uh, molecules are bottled up in the
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  strait, demand will have to fall, and the way demand falls, uh, in
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  this scenario is through, uh, demand destruction via the price channel.
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  So prices go up and, uh, you know, demand falls, growth falls, industrial
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  output falls, and, uh, the countries that are not insulated, uh, against
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  that, again, the ones who don't have buffer stocks, don't produce and
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  have to go into the spot market, those are the ones, uh, most at risk.
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  One final question.
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  So how are central banks navigating this mix of geopolitical risk,
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  inflation pressure, and uneven growth?
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  Supply shocks are tough for central banks, right?
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  Because, uh, uh, inflation tends to go up and, uh, output tends to go
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  down, which would, uh, which would put downward pressure on inflation.
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  So there are, uh, mixed signals.
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  It's pretty clear right now that central banks are on a… in a wait and
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  see hold and kind of leaning higher.
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  If it's a pure supply shock, central banks, or at least credible central banks,
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  should be able to look through this.
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  A credible central bank is one that has established its, uh, you know,
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  ability to deliver its inflation target.
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  And in those countries, you would see inflation expectations over the
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  medium term relatively well-anchored.
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  So the price shock, the price jump can work through the system and then,
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  you know, kind of fade out as the shock, uh, as the shock winds down.
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  Uh, what we've seen right now is, uh, central banks have definitely
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  stopped, uh, cutting rates.
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  Most of them are on hold, and they're kind of what we call hawkish holds.
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  They're leading, leaning higher, signaling that if this price, uh, shock lasts
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  for longer and if the, you know, the inflation starts to spill into, uh, you
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  know, everyday wages and prices, what we call second-around effects, then
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  central banks may need to, uh, tighten.
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  But it's, uh, it's a tough situation and, uh, growth and inflation are
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  going in different directions.
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  But, uh, I suspect we're probably gonna see a, a few central bank
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  heights-- hikes before we get back to the end of the cutting cycle,
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  which is where we were when all of this, uh, started earlier this year.
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  Paul, thank you so much for helping us, uh, frame what really matters,
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  uh- My pleasure … as this plays out.
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  And I, I can tell the key message today is, um, the conflict pushes risk
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  toward higher for longer inflation, complicates growth, and does so
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  through energy and supply channels that are much harder to offset.
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  And all of this is landing on an already unsynchronized global
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  economy, making policy trade-offs sharper and coordination harder.
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  If you would like to dive deeper into our research and our blog posts,
• 16:00
  visit spglobal.com and explore our Look Forward Council resources.
• 16:05
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• 16:07
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