Inflation spillovers from the Middle East

The outbreak of the U.S.–Iran conflict has significantly disrupted the flow of goods and energy from the Middle East. Most market attention is focused on the impact on oil and natural gas markets, as we have written about previously, and Asia is likely to be disproportionately impacted. While oil and the energy disruption might be the bigger headline when it comes to the inflation and growth outlook for Asia and the world, there will be consequences across many sectors of the economy as disrupted shipping through the Strait of Hormuz becomes a broader supply-and-logistics shock that pressures inflation higher. More persistent second-round effects and spillovers will begin to form in the background that will impact Asia.

We should keep in mind that the region is a transit hub. The Strait of Hormuz is not only a corridor for energy, but also for bulk commodities and chemical cargoes that support manufacturing and agriculture. Even without a complete shutdown, sporadic interruptions and risk aversion can create congestion, reduce effective shipping capacity, and lift shipping costs.

It is not just oil we have to worry about

There is a risk that an oil shock turns into a food shock. Close to 20% of global fertilizer supply originates from the region, and prices for important fertilizer components like urea have surged. The region is also critical for sulfur, accounting for around half of global exports, which matters because sulfur is an important input in fertilizer production. Similar to what happened in the oil market in 2022, the outbreak of the Russia–Ukraine conflict offers a useful historical example. Ukraine was a significant producer of fertilizer, and the fighting saw prices soar. This was followed by food inflation rising by double digits several months later, as seen in Exhibit 1 below. A similar response is likely in our view, with food production facing a double dose of trouble in the form of higher fuel costs not only for transportation but also for agricultural equipment use. 

Food inflation tends to respond with a lag. Much of what people eat today was grown months ago, so the bigger impact from higher urea prices is likely to show up in future harvests. A fertilizer shortage or sustained price spike can reduce yields in the next crop cycle, and farmers may pass on higher costs both in anticipation of further shortages and when the next harvest reaches the market. That lag can make early inflation data look benign and can tempt markets to assume the risk is low.

Even if shipping conditions improve, normalization may take time: reopening the Strait of Hormuz would not instantly restore trade after production disruptions and shipping dislocation. If natural gas infrastructure has been damaged, that also points to more persistent supply constraints and elevated fertilizer prices. 

Issues spiral beyond food prices into supply chains

The Strait’s importance extends beyond energy and agriculture. The region is also meaningful for petrochemicals and chemical precursors used throughout manufacturing supply chains; disruptions there can raise input costs for packaging, textiles, consumer goods, and industrial components. Metals can be exposed as well, not only through higher energy costs in energy-intensive processing but also through shipping disruptions for raw materials; around 10% of global aluminum production passes through the region. For high-tech manufacturing, even niche materials can matter if supply is concentrated and inventories are limited. Around one-third of global helium production, which is needed for chip fabrication, goes through the chokepoint. The risk is not only price increases but also production scheduling problems when a single input becomes scarce.

If inflation accelerates, a key question is whether consumers can draw down excess savings or reduce spending without triggering a sharper slowdown. In some markets, like China and South Korea, savings buffers still exist; in others, like the Philippines, savings buffers have been decreasing, and higher essentials inflation translates quickly into weaker non-essential spending. Because items like food purchases are non-discretionary and frequent, a rise in staples can feel more severe than an equivalent rise in fuel. It can erode purchasing power and sentiment, which will eventually cut into growth.

Many Asian governments have responded with subsidies, price caps, tax cuts, targeted transfers, or administrative measures. Those tools can soften the short-term blow to consumers and help avoid a collapse in discretionary spending, but they come with trade-offs. If fiscal headroom is limited, more spending on offsets and subsidies can crowd out other priorities, including public investment, and can complicate the inflation fight if it sustains demand while supply remains constrained. Singapore, South Korea, and Taiwan are better positioned to deploy supplementary budgets due to strong corporate tax revenues from the tech and artificial intelligence (AI) boom, while markets like India, Malaysia, the Philippines, and Thailand face more limited fiscal space.

Investment implications

Even if the initial market reaction looks contained, the conflict’s inflationary impulse may still be working its way through the system with a lag. Disruptions to shipping lanes, fertilizer and chemical inputs, and energy-linked supply chains can translate into higher delivered costs over the coming months, particularly for food and manufactured goods, and these pressures can persist even after headlines fade if trade flows and production take time to normalize.

We may see a split in performance along two key factors in Asia: markets focused on AI versus non-AI and energy importers versus exporters. Those markets riding the AI wave and less reliant on energy imports have a more positive outlook. The potential for higher inflation means higher rates are also more likely, which could mitigate the benefit of fixed income. It will pay to be selective in this space and to keep in mind which markets may see outsized reactions from their central banks.

For investors, the key risk is complacency: second-round effects can arrive later and prove stickier than the initial move in oil, with knock-on implications for Asian growth, corporate margins, and policy settings. Until there is clearer evidence that logistics, input prices, and inflation data are stabilizing, it would be sensible for investors to remain cautious and to reduce risk exposure by increasing allocations to fixed income and defensive sectors.

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