Investors concerned about the fallout from the war in the Gulf were initially focused on the inflationary pressure of higher oil prices, triggering a global bond market rout that deepened over the past week. But a new worry has taken a more serious grip: stagflation, the dreaded mixture of high inflation and stagnant growth.
“Markets are beginning to price a more persistent ‘higher for longer’ oil backdrop,” said Emmanuel Cau, head of European equities strategy at Barclays. “This dynamic is reinforcing stagflation concerns.”
Evidence of such worries can be seen in stocks, generally more sensitive to growth than inflation. Global stock indices — led by energy importers in Asia and Europe — jolted lower in recent days, having been relatively muted for the previous few sessions.
Elliot Hentov, chief macro policy strategist at State Street Investment Management, said that “the ‘stag’ drivers [are] outweighing the ‘flation’ drivers in a global oil shock”.
The prospect of stagflation is adding to central bankers’ headaches by pitting concerns over growth and inflation against each other, while investors are trying to find havens to protect their portfolios.
For now, though, inflation seems to be front of mind, as swaps markets show investors adding to bets on tighter rather than looser monetary policy in the US, Europe and the UK. Emily Herbert
What will business activity tell us about the path of US interest rates?
Investors will be watching US purchasing managers’ indices for signs of vulnerability in the world’s largest economy as the war in the Middle East continues.
On Tuesday, S&P Global will release its PMIs for the US manufacturing and services sectors, offering a first glimpse into how American businesses are weathering the initial stages of the US-Israeli war in Iran. Below the headline numbers, investors will scrutinise new orders, employment and input costs for any signs of economic decay. Inflation metrics within the report will be of particular interest, as the US economy grapples with rising fuel costs.
Any indication of price pressures would be likely to validate the Fed’s hesitant approach to easing policy. At this week’s meeting, policymakers generally anticipated only a single quarter-point interest rate cut this year and chair Jay Powell said he believed the Iran war would lead to a rise in the rate of inflation.
However, signs of weakness in business activity may not lead to relief in the form of lower interest rates. As surging oil prices push inflation expectations upwards, a pivot towards looser monetary policy appears increasingly improbable. Traders in futures markets have pivoted away from pricing any cuts at all this year, with some now placing bets on a potential rate increase to keep prices in check.
Investors are likely to weigh the US results against data from other big economies. Any significant divergence between US and European PMIs could spark volatility in currency markets, particularly if the gap suggests widening interest rate differentials between the two regions. Kate Duguid
How exposed is the UK economy?
Investors will scrutinise data next week for signs of underlying UK price pressures ahead of a fresh rise in energy costs, as well as early evidence of how the Middle East conflict is affecting business and consumer sentiment.
Economists polled by Reuters expect inflation of 3 per cent in February, unchanged from January, in data due on Wednesday. A rise in alcohol duty rates, which took effect on February 1, is expected to contribute to price pressures.
Before the Iran war, the Bank of England expected inflation to fall to 2.1 per cent in the second quarter. It now forecasts price growth of 3 per cent, with inflation climbing to 3.5 per cent in the third quarter as energy prices feed through.
“The conflict in the Middle East will be damaging for the UK economy, increasing inflation and reducing output,” BoE deputy governor Clare Lombardelli said this week as policymakers opened the door to higher interest rates.
The surge in natural gas prices that followed attacks on Qatar’s gas infrastructure prompted Robert Wood, economist at Pantheon Macroeconomics, to estimate inflation possibly rising to 4 per cent later this year.
“We are beginning to add second-round effects to our inflation forecasts now,” which “prolong the likely period of above-target inflation”, said Wood.
The first indications of the conflict’s effect on business sentiment are likely to emerge on Tuesday with the release of S&P Global’s purchasing managers’ indices. Economists expect rising uncertainty and the prospect of higher costs to weigh on confidence and new orders.
A similar pattern may be reflected in consumer sentiment data due on Friday. GfK’s March confidence index is expected to fall 3 points to minus 22, according to Investec economist Sandra Horsfield. Valentina Romei
