The abrupt shutdown of the Strait of Hormuz in the Middle East has jolted global markets, sending oil prices above USD 100 per barrel. Inflation is the dominant narrative at the moment, but as we look ahead, we believe markets should start to focus more on growth. As this month’s chart shows, one‑year‑ahead GDP forecasts typically decline by roughly 0.5% to 1.5% following sharp oil spikes, reflecting tighter real incomes, weaker consumption and reduced activity in energy‑sensitive sectors.
Uncertainty remains high around the length and intensity of the current conflict. However, we’d expect a drag on growth even in a benign scenario where tensions ease quickly, given oil prices are unlikely to return to pre‑crisis levels of close to USD 60 in the near term. Elevated energy costs act as a tax on consumers and businesses, with a particular impact on lower-income households. Some degree of demand destruction would therefore be expected as persistently higher oil prices squeeze discretionary spending and dent consumer confidence.
How central banks react will be the key question for rates markets. So far, policy makers from the Federal Reserve, European Central Bank and Bank of England have pointed to increased uncertainty, while also warning that inflation could reaccelerate. The most recent reference point for markets is the policy response during the 2022 supply shock. However, we would argue that the economic backdrop is very different today. Back then, supply bottlenecks and already‑high inflation, combined with historically tight labour markets and rapid wage growth, led to aggressive tightening. Today, core inflation has moderated, wage growth has cooled, and labour markets are softening across many advanced economies. Interest rates are also already in restrictive or neutral policy, unlike the 2022 era of ultra-low rates. Given the weaker growth impulse and more benign underlying inflation trends, the current macro backdrop suggests we could see rates remain on hold for a prolonged period, or moderate hikes, rather than the aggressive hiking cycle that is being priced in for some markets.
While market pricing has reacted quickly to the potential inflationary impacts from higher oil, the downside growth risks have yet to be fully reflected. That asymmetry in pricing suggests that intermediate duration is becoming more attractive. If central banks keep policy restrictive and the growth drag from higher energy costs intensifies, then owning duration in the belly of the curve could provide an attractive source of value to fixed income investors in the long-term.