Middle East Escalation Boosts Oil Supply Risks

Energy

Palestinian-Israeli conflict

Summary:

The oil market continues to be supported by ongoing tensions in the Middle East. The lack of price action following recent escalation has been surprising but suggests there...

The risk of disruption to Middle Eastern supply grows

While price action in the oil market has been somewhat surprising following Iran's attack on Israel, the risk of tensions in the Middle East impacting oil supply is certainly growing.

The lack of price strength following Iran's recent attack is largely due to a large risk premium already having been priced into the market. ICE Brent rallied from a little more than US$86/bbl at the start of April to over US$90/bbl in anticipation that Iran would respond to Israel's suspected airstrike on its embassy in Syria. Secondly, the market is also in limbo, waiting to see how Israel responds to the recent attack. The longer the market waits for Israel's response the more likely the risk premium starts to fade.

Risks to oil supply because of the ongoing tension in the Middle East are at their highest since October last year. Any further escalation would only bring the oil market closer to actual supply losses We believe there are three key supply risks facing the oil market as a result of current tensions. These include stricter enforcement of oil sanctions against Iran, Israel retaliating by targeting Iranian energy infrastructure and the worst-case scenario - that significant escalation eventually sees Iran attempting to block or disrupt oil flows through the Strait of Hormuz.

Stricter sanctions enforcement

Israel's allies are pushing for a diplomatic response to Iran's attack, although it would appear that Israel is looking at a potentially more aggressive approach.

The US and Europe are looking at potentially imposing stricter sanctions against Iran following the attack. The US already has oil sanctions in place against Iran.

The issue is that the US has not strongly enforced these sanctions since Russia's invasion of Ukraine, given concerns over oil supply and higher prices. As a result, Iranian oil supply has grown from an average of a little over 2.5m b/d in 2022 to close to 3.2m b/d in March 2024. If the US was to properly enforce sanctions, it would leave around 700k b/d of supply at risk.

There is potential for further supply losses due to sanctions. Legislators in the US are considering a bill called the Iran-China Energy Sanctions Act, which would attempt to crack down on Iranian oil flows to China. There is also scope for the EU and other allies to agree on multilateral sanctions, which would only make it more difficult to move Iranian oil.

While new sanctions might be introduced, the key question is whether these sanctions will be more strictly enforced. There will be concerns over the potential impact supply losses could have on oil prices, and the Biden administration would not want to see higher oil prices and pump prices in the lead-up to US elections later in the year.

If we were to see stricter enforcement of sanctions, this is not something that will become immediately apparent to the oil market. It will take time for it to become noticeable in tanker tracking data.

Losing in the region of 700k b/d of Iranian oil supply would be enough to push the oil market into small deficit over the second half of the year, which would imply ICE Brent averaging US$92/bbl in 4Q24 versus our current forecast of US$85/bbl for the final quarter of the year. This is under the assumption that OPEC+ decides against rolling over supply cuts into the second half of the year.

Iranian supply disruptions

With it still unknown how Israel will respond to Iran's attack, we cannot fully rule out the potential for Israel to target Iranian energy infrastructure. Iran is an important oil producer, with it being the fourth largest OPEC member, pumping close to 3.2m b/d. Any targeting of Iranian energy would likely provide a boost to oil prices.

We believe the likelihood of Israel targeting energy infrastructure is rather small. This would not go down well with allies, given the impact it would have on oil prices.

If we assume that the bulk of Iranian oil exports are halted, we could see Brent average a little under US$100/bbl in 4Q24.

Iranian escalation and the Strait of Hormuz

The worst-case scenario for the oil market would be if we saw escalation to an extent where Iran attempts to impose a blockade through the Strait of Hormuz. The Strait of Hormuz is the most important chokepoint globally for oil trade. A little over 20m b/d of oil flows through the Strait, with exports from key producers Saudi Arabia, Iraq, Iran, the UAE, Kuwait and Qatar.

We believe the likelihood of a blockade is low, given firstly, it would be difficult to impose, secondly, it would not be in Iran's own interest, and finally, it would likely see a strong global response. However, it is still worth exploring the impact.

The potential impact would dwarf the disruptions we have seen in the Red Sea in recent months, given the volume of oil that flows through the Strait and also due to the fact that there is no alternative route for the bulk of these oil exports. As we mentioned in a note earlier in the year, Saudi Arabia does have 5m b/d of pipeline capacity, which would allow crude to be carried to the Red Sea and exported from there, while the UAE has a pipeline with capacity of 1.5m/b/d which would allow for the export of oil from the Gulf of Oman, so avoiding the Strait. This still leaves approximately 14m b/d of oil supply at risk in the event of a blockade.

This would lead to a significant price shock where we could see Brent break above US$200/bbl by the end of the year, given the significant drawdown we would see in global stocks. Prices would need to remain elevated to ensure significant and rapid demand destruction, and any supply response from other producers would take time.

How could supply losses be dealt with?

The ability of the market to respond to any potential supply disruption would depend on the severity of any supply cuts. Given that OPEC is sitting on more than 5m b/d of spare production capacity this means that the market should be well placed to respond to most supply hits. This will largely depend on the willingness of OPEC to increase supply. The group will likely become increasingly concerned about potential demand destruction if prices move too high, sustainably above $100/bbl.

OPEC spare capacity would be able to help the global market in the case of stricter sanctions against Iran or any significant supply disruption from Iran. Where this spare production capacity does not help, is if there was a blockade of the Strait of Hormuz - the bulk of spare capacity sits within the Persian Gulf. Saudi Arabia, the UAE, Iraq and Kuwait hold 95% of total OPEC spare capacity.

Any significant supply shocks would also likely lead to a coordinated global release of stocks from emergency reserves. While the US has drawn down significantly on its strategic petroleum reserve (SPR) since Russia's invasion of Ukraine, the SPR still stands at more than 360m barrels, leaving it with the option to tap into this.

Significantly higher prices would also ensure there is a clear incentive for producers elsewhere to increase drilling activity. While US producers would be the quickest to respond, it would still take several months for increased drilling activity to feed through to higher oil supply.

The key takeaway is that the oil market from a supply perspective should be able to cope relatively well with any disruptions/losses to Iranian supply. Where it becomes increasingly more difficult for the market is if Persian Gulf supplies are lost due to a blockade of the Strait of Hormuz. Middle East Escalation Boosts Oil Supply Risks_2

Middle East Escalation Boosts Oil Supply Risks_2

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Thomas

Economic

Central Bank

When consumer price inflation first reared its ugly head in the aftermath of the Covid-19 crisis, the initial reaction of central bankers and politicians was to dismiss it, along with anyone expressing concern over it. As Federal Reserve Chair Jerome Powell put it, consumer price increases were merely "transitory" and nothing to be too worried about.

Once it became clear that it would not be such a short-lived problem after all, and that inflation was here to stay, much of the mainstream financial press echoed the narrative of political leaders who blamed it all on "supply chain issues." According to that theory, prices were climbing due to the lingering effects of the lockdowns, business shutdowns and logistical disruptions to global trade during the pandemic. While not entirely implausible, this rationale failed to account for across-the-board price hikes. It was not just specific industries or particular categories of goods that were affected; everything was getting more expensive, and fast.

Another explanation blamed the Russian invasion of Ukraine – arguing that the war and subsequent sanctions against Moscow had wreaked havoc on energy markets, and as oil and gas got more expensive, everything else did too. This line of reasoning appears sound on the surface. The problem is that the consumer price increases preceded Russia's invasion by months, so even though the war might have aggravated pressures in the energy market, it did not cause the larger global inflationary wave we experienced.

'Greedflation'

As months passed with consumer price indexes (CPI) breaking records in many advanced economies, and as households were pushed into dire financial straits, public discontent made it imperative for politicians to find a scapegoat. "Capitalist greed" was a natural choice.

As Fortune reported, "Albert Edwards, a global strategist at the 159-year-old bank Societe Generale, released a blistering note on the phenomenon that has come to be called 'greedflation.' Corporations, particularly in developed economies like the U.S. and the UK, have used rising raw material costs amid the pandemic and the war in Ukraine as an 'excuse' to raise prices and expand profit margins to new heights."

There is no doubt that individual companies took advantage of the inflation narrative to raise prices, and to levels much higher than what their actual cost increases could justify. However, they could only do so because of preexisting and widely recognized price increases – this "passing on the cost" excuse would never have worked in an environment that was not already perceived as inflationary. No group of bad actors, greedy CEOs or rogue corporate executives could possibly have managed to raise consumer prices across the board and throughout the entire world economy.

Even if some companies did try to squeeze out some extra profits by feigning or exaggerating increased costs and unjustifiably hiking their prices, the "greedflation" explanation still fails to account for the concomitant price increases across so many other commodities, companies, sectors, regions and nations. As with the Ukraine war theory, instances of corporate avarice might have exacerbated the problem, but they did not cause it.

The idea that corporate profiteering is the main inflation driver not only puts the cart before the horse, but it contradicts the prior explanations. If there were pandemic-related supply chain bottlenecks and energy market distortions caused by the Ukraine war, then it means the cost of raw materials did increase for producers, justifying higher prices.

Political appeal

As misleading as this theory is, it is undoubtedly politically attractive. United States President Joe Biden embraced it during a February meeting with union workers in Las Vegas ahead of Nevada's Democratic primary, where he blamed corporate greed for high inflation. This narrative appears to have gained considerable traction. A poll by Navigator Research found that "since January of 2022, there has been a 15-point increase in the share who say 'corporations being greedy' is a 'major cause' of inflation (from 44 percent to 59 percent), with 17-point increases among independents (from 45 percent to 62 percent) and Democrats alike (from 55 percent to 72 percent)."

One can see how appealing such a populist concept can be, especially to those who have seen the real value of their paychecks shrink even as corporate profits and CEO bonuses explode. And it is not just politically expedient: it also helped sell the idea of the Global Minimum Tax on corporations to curb "excess" profits, which was further advanced this January after years of talks at the Organisation for Economic Co-operation and Development. How the Real Cause of Inflation Has Become a Moving Target_1

How the Real Cause of Inflation Has Become a Moving Target_1

While blaming big corporations might have helped channel public anger toward supposedly evil capitalists and the rich, it did not do anything to solve the actual problem of inflation. In fact, the situation for most ordinary people became even more difficult. Even as official CPI readings have climbed down from their record highs in recent months, the higher interest rate policies used to achieve that result have amplified the financial pressures on the average household.

In the U.S., credit card balances increased by $50 billion, to a total of $1.13 trillion, during the last quarter of 2023, according to the Federal Reserve Bank of New York, while interest rates on credit cards rose from an average of 14.6 percent to 21.5 percent since the Fed began its series of rate hikes. Overall household debt reached an unprecedented high of $17.3 trillion at the outset of 2024.

Blaming consumers

The pain caused by the tightening measures might have been worth it for many people if it had actually made a noticeable difference in lowering their grocery bills or other basic expenses. But despite the picture painted by official CPI readings, that did not happen (this is because these readings are unrepresentative of the real economy).

As public anger began to swell once again, a new theory was needed for why so many average citizens were struggling to afford both credit card payments and daily necessities. Having run out of villains to blame, the latest narrative sought to blame consumers themselves.

"Doom spending" is the newest concept deployed in the inflation debate and it effectively seeks to explain higher prices as a product of higher demand. Proponents say that higher demand stems from overwhelmed consumers (particularly Gen Z and millennials) who are crippled by anxiety and fears over economic uncertainty and the general state of the world. These people, the argument goes, seek relief through mindless spending, especially on luxury goods, big-ticket items and expensive traveling.

The evidence for this hypothesis is either anecdotal or based on poor-quality surveys. It also does not explain why this kind of consumer behavior has not been observed during previous eras of strife or challenges. Why did consumers not splurge on designer handbags to manage their stress after 9/11, during the eurozone crisis, or even at the height of the pandemic?

As Occam decreed, the simplest explanation is the right one. Put plainly, the core problem has never been about goods and services increasing in price; it is about money itself decreasing in value. The cause is also quite straightforward: chronic monetary and fiscal profligacy, also known as the "print and spend" doctrine embraced in most advanced economies.

Source: GIS

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Kevin Du

Energy

China's wind farms produced over 100 terawatt hours (TWh) of electricity in March, the highest monthly total ever by a single country and as much as all of Europe and North America combined, data from energy think tank Ember shows.

The production total was 25% more than during the same month in 2023, and helps extend China's dominant position as by far the world's largest renewable energy producer.

China's output total in March was more than twice the generation in the United States, the second largest wind producer, and nearly nine times more than produced in Germany, the number three producer.

China Widens Wind Power Lead with New Generation Record_1

However, the March tally may also be the highest for the year, as seasonal wind speed changes mean that China's annual peak for wind output typically occurs around March or April, before declining through the summer as wind speeds slow.

Nonetheless, the output record marks a new milestone for clean energy trackers, and ensures that China remains the leading driver of global clean energy output.

Widespread Progress

China's wind power generation stems from several large wind installations across the country.

Some areas, especially Inner Mongolia in the north and Xinjiang in the west, host some of the world's largest wind farms, and account for the largest share of China's wind power output.

But the build-out of wind generation capacity is taking place in all regions, resulting in a growing volume of clean energy in all major power-consuming regions. China Widens Wind Power Lead with New Generation Record_2

China Widens Wind Power Lead with New Generation Record_2

And output in all provinces, including Guangdong in the south, Yunnan in the southwest, Anhui in the east, and Heilongjiang in the northeast, have recorded close to record high production totals so far in 2024.

That widespread rise in wind output has helped push wind power's share of China's total electricity generation steadily higher, to an average of 11.4% during the first quarter of 2024 from 9.6% during all of 2023, according to Ember.

That share compares to around 62% for coal and around 12% for hydro, and so cements wind power as China's third largest source of electricity. China Widens Wind Power Lead with New Generation Record_3

China Widens Wind Power Lead with New Generation Record_3

Solar power grabbed a roughly 6% share of China's total electricity generation in 2023, and will likely expand that share in 2024 thanks to continued increases in solar generation capacity in the country.

Solar power will also play a critical role in boosting electricity generation during the summer months, when overall power demand in China is at its highest due to rapidly rising use of air conditioners.

But wind farms will likely remain the most important source of renewable power in China for the foreseeable future, due in large part to their ability to produce electricity even when the sun doesn't shine, and from locations spread throughout the country and often close to major demand centres.

Further growth in domestic wind power generation capacity is also expected throughout 2024 and beyond as part of Beijing's ambitious plan to reach carbon neutrality by 2060.

That means even higher wind power generation totals can be expected going forward, ensuring that China will retain its position as the global wind sector leader.

Source: Reuters

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Alex

Economic

Central Bank

The United States economy has had a good run. Gross domestic product (GDP) growth is encouraging (2.5 percent in 2023 and more than 3 percent during the last 2023 quarter), and the February 2024 price inflation rate was down to 3.2 percent – higher than expected but still a commendable result.

The labor market is in great shape. Last February, the unemployment rate was 3.9 percent, and in January the job openings rate was 5.3 percent: although this figure is dropping, it remains significantly higher than it averaged in the past (3.5 percent). In other words, unemployment is not a problem, and the demand for labor is vibrant.

This is, of course, good news for the U.S. Federal Reserve Chair Jerome Powell, and President Joe Biden now has plenty of encouraging economic results to support his reelection bid. There are a few clouds on the horizon, however.

Interest rates and 'corporate debt cliff'

Many assumed that the Fed would soon make credit less costly and more readily available – but they have been disappointed. The Fed's 2 percent inflation target may not be achieved by the end of this year, and there are fears that tight monetary conditions might weaken GDP growth. Such worries are partially justified.

Many American companies took advantage of the long period of abnormally lax credit conditions. They borrowed heavily, especially during the worst of the Covid-19 pandemic, and a large share of those debts are to mature in the next couple of years. Many companies will not be able to pay them back and will try to refinance their past borrowing through new loans.

The cost of debt servicing on those new loans is undoubtedly going to be higher than anticipated. If interest rates do not drop significantly during the next quarters, many balance sheets will take a heavy hit, and some borrowers could go broke.

This is the so-called "corporate debt cliff" created by years of irresponsible monetary policy. Depressed interest rates ended up rescuing inefficient businesses that should have suffered losses or gone bankrupt a long time ago. Instead, they kept draining scarce resources from the healthy part of the economy. The cliff will, at long last, eliminate the poor performers, but it will not be painless.

Doing the right thing

There is also some good news. Broadly speaking, the monetary picture is improving. Regrettably, no one knows what the interest rates should be because the authorities keep manipulating money and credit markets, but the Fed is aware that there is much liquidity around. The nominal money supply (M2) is currently just below its 2022 peak and twice as high as its 2014 level. Indeed, keeping interest rates relatively high is the only way of eliminating the monetary overhang.

In other words, the Fed is doing the right thing and, hopefully, will stay the course even after the presidential election. Its policy of steadying the monetary picture will draw some flak and take time. However, it produces a welcome result: The probability of reducing inflation without causing a recession (a "soft landing") is considerably higher today than it was just a year ago.

The government keeps adding to the debt

Another, and potentially more severe, threat is public finance. At the end of 2023, the U.S. government debt was about 124 percent of GDP. This figure is below the 2020 peak of 127 percent, but it is still high.

On the one hand, there is bad news for the Department of the Treasury: the budget deficit continues to add to the accumulated debt; the Fed seems unwilling to buy U.S. securities (Treasuries) to the extent it did in the recent past; and relatively high interest rates make debt servicing expensive. On the other hand, there is good news: productivity has increased faster than expected and generated enough growth to stabilize the debt-to-GDP ratio and keep markets happy. Public Debt Spells Trouble for the U.S. Economy _1

Public Debt Spells Trouble for the U.S. Economy _1

Moreover, the rise in productivity has not been matched by an increase in salaries. Thus, profits have been rising, and more investment resources are available. The debt burden is heavy, but the economy is in good shape, and there is no shortage of buyers of U.S. securities.

However, some caution is in order. The 2024 budget deficit is expected to be 5.6 percent of GDP. Of that, 2.5 percent is the so-called "primary deficit" (the fiscal deficit for the current year minus interest payments on previous borrowings), while 3.1 percent is debt servicing. Now, since about one-third of the U.S. public debt must be refinanced by the end of 2024 at interest rates higher than those obtained in the past, the cost of debt servicing could rise by about 0.4 percentage points, to some 3.5 percent of GDP. Hence, the key to stabilizing the burden of debt is the primary deficit, which must not exceed the current level – or drop if growth slows down.

The real yield on the 10-year Treasury is currently about 1 percent, which is not high by historical standards, especially if the economy grows faster than 2 percent. It is reasonable to expect that real interest rates will rise further, especially if corporate America remains in good health. Regardless of Mr. Powell's hints to the contrary, the margin for a nominal interest rate cut is limited.

If private companies offer better investment options, it might be difficult for the government to sell its bonds unless it provides a high coupon (the annual interest rate) to attract investors. Put differently, markets do trust the U.S. dollar as a safe currency and the U.S. government as a solvent debtor. However, suppose companies believe that this high level of productivity growth is going to last. In that case, corporate bonds will flood the market, and debts – private and public – will be financed or refinanced at relatively high rates.

Source: GIS

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ING

Economic

Commodity

Metals prices will rise short-term, but there is a limit

No Russian nickel, aluminium and copper produced from 13 April onwards will be eligible for delivery to the LME or the Chicago Mercantile Exchange (CME). The US is also banning Russian imports of all three metals.

Russia accounts for about 6% of global nickel production, 5% of aluminium and 4% of copper. For nickel, Russia is the world's second-largest producer of refined class 1 nickel behind China, the only type that is deliverable on the LME. What New Metal Sanctions on Russia Mean for Global Trade_1

What New Metal Sanctions on Russia Mean for Global Trade_1

In the US, a minimal effect on supply is expected. For example, the US has been less dependent on Russian aluminium, which accounts for less than 1% of US aluminium imports. However, the move could impact the metal's global trade.

The move will be bullish for prices on the LME, which are used as a benchmark in contracts around the world. The LME nickel prices, in particular, remain vulnerable to major price spikes following the nickel squeeze in March 2022 after Russia's invasion of Ukraine and a build-up in short positions on the exchange. However, the LME has placed daily limits which prevent prices from rising more than 12% in a day for copper and aluminium and 15% for nickel.

Russian metal will flow to sanction-neutral countries

The LME is a market of last resort for the physical metals industry. Although most metals traded globally are never delivered to an LME warehouse, some contracts stipulate that the metal should be LME deliverable.

This means that Russian companies will be forced to accept lower prices. Russia-origin metals will trade at even wider discounts and will continue to flow to sanction-neutral countries, like China, the world's biggest aluminium consumer.

China's imports of primary aluminium from Russia hit new highs last year, and this trend is likely to continue. China is likely to continue to buy discounted Russian material to use domestically and export its aluminium products into Europe and the US to fill the gap left by Russian import ban. What New Metal Sanctions on Russia Mean for Global Trade_2

What New Metal Sanctions on Russia Mean for Global Trade_2

Surpluses of Russian metals build up in LME warehouses

Russian metals had broadly escaped sanctions until December, when the UK prohibited British individuals and entities from trading physical Russian metals, including aluminium, nickel and copper. However, at the time, the UK had included an exemption allowing trade on the LME to continue. Britain is the only country in Europe to have adopted such measures.

The UK sanctions initially barred UK persons from requesting delivery of Russian metal from the LME. However, this restriction has now been removed as long as the metal was already in the exchange's system before 13 April.

The LME had previously considered banning Russian metal in 2022 but ultimately decided against it and said it would be guided by government sanctions. Canada announced a ban on Russian aluminium and steel products in March 2023.

Meanwhile, European buyers have been self-sanctioning since the invasion of Ukraine, leading to fears that LME warehouses could be used as a dumping ground for unwanted Russian metals.

Large surpluses of Russian metals have built up in LME warehouses. At the end of March, Russian metal accounted for 36% of the nickel in LME warehouses, 62% of the copper and 91% of the aluminium. These existing inventories would not be affected by sanctions, the LME said, and can continue to be delivered, though the exchange said it would require evidence that the metal was not in breach of sanctions and would approve deliveries on a case-by-case basis. What New Metal Sanctions on Russia Mean for Global Trade_3

What New Metal Sanctions on Russia Mean for Global Trade_3

A new flood of deliveries into LME warehouses of Russian metal that was being held off-exchange is now likely, which could push copper, aluminium and nickel contracts wider into contango, a market structure signalling ample near-term supplies, which for these three metals are already at historically wide levels. This could, in turn, lead to a further disconnect between LME and actual traded prices.

Ultimately, the new restrictions won't change these three metals' supply and demand balances. Prices of copper, nickel, and aluminium are likely to initially move higher, and in the short term, the market will remain volatile, mainly due to the large uncertainty in supply and LME delivery post-sanctions changes. However, the market is likely to adapt to the new dynamics while Russian material will continue to find new sanction-neutral buyers. What New Metal Sanctions on Russia Mean for Global Trade_4

What New Metal Sanctions on Russia Mean for Global Trade_4

In April 2018, the US administration placed sanctions on Russian aluminium producers. LME prices jumped to $2,718/t, at the time the highest since 2011, before gradually falling in the following weeks and months. Sanctions were then lifted in January 2019.

To stay updated on all economic events of today, please check out our Economic calendar

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Owen Li

Energy

Oil prices are up around 16% so far this year near $90 a barrel, with supply worries high given escalating Middle East tensions and tit-for-tat attacks on energy infrastructure between Ukraine and Russia.

Investors are paying attention. After all, it was an energy price surge two years ago that helped drive inflation and interest rates higher on a scale not seen in decades. What The Fresh March Higher in Oil Means for World Markets_1

What The Fresh March Higher in Oil Means for World Markets_1

The International Monetary Fund on Tuesday described an "adverse scenario" in which an escalation of conflict in the Middle East would lead to a 15% jump in oil prices and higher shipping costs that would hike global inflation by about 0.7 percentage points.

The tightness in oil supplies, and higher prices, has been underpinned by oil producing group OPEC and other big oil producers curbing their output.

Morgan Stanley has lifted its third quarter Brent crude oil forecast by $4 per barrel to $94. With oil prices expected to stay high, we look at the fallout for world markets.

Inflation Watch

After U.S. inflation came in higher than expected for a third straight month in March, the spectre of inflation staying higher has returned with bets on interest rate cuts scaled back sharply.

Softening energy prices have been a principal driver of lower inflation expectations recently. Higher oil prices are seen as a threat to this trend.

A key market gauge of long-term euro zone inflation expectations, which generally track oil, on Tuesday hit its highest since December at 2.39%. The European Central Bank has a 2% inflation target. What The Fresh March Higher in Oil Means for World Markets_2

What The Fresh March Higher in Oil Means for World Markets_2

ECB chief Christine Lagarde said on Tuesday fresh turbulence in the Middle East had so far had little impact on commodity prices. Oil, while near recent highs, has eased a little this week.

Still, the ECB has said it is "very attentive" to the impact of oil, which can hurt economic growth and boost inflation.

Zurich Insurance Group chief markets strategist Guy Miller said economies can survive, and producers are reasonably happy, when oil is around $75-$95 a barrel.

"But were we to see this to break higher then, yes, that would be a concern both from a growth and inflation perspective," he said.

Go Energy Stocks

Energy stocks are a clear winner from higher oil prices. The S&P 500 oil index and European oil and gas stocks remain close to record highs.

U.S. oil stocks have jumped almost 13% so far this year, outperforming the broader S&P 500's 6% gain. What The Fresh March Higher in Oil Means for World Markets_3

What The Fresh March Higher in Oil Means for World Markets_3

Ed Yardeni, founder of Yardeni Research, said a rise in Brent crude to $100 in coming weeks was a possibility, recommending an "overweight" position on energy stocks.

Oil was last above $100 in 2022. It briefly spiked to around $139 after Russia invaded Ukraine, its highest since 2008.

"I believe you have to overweight energy as at least a shock absorber in your portfolio in the event that oil prices continue to go higher," said Yardeni.

Barclays head of European equity strategy Emmanuel Cau has had an overweight position on Europe's energy stocks since October, saying the sector tends to perform well in inflationary and stagflationary environments.

In contrast, Nordea CIO Kasper Elmgreen said he was negative on energy stocks because the costs associated with an energy transition were not correctly priced yet.

"They (energy firms) are going to have to carry a much higher burden for the drive to net zero, and that's not being reflected in the share price," said Elmgreen.

Robust Dollar

2024 kicked off with expectations the dollar would decline as inflation weakens and allows the Federal Reserve to start cutting rates.

Instead, the greenback is up 4.7% this year as rate-cut bets are slashed.

What The Fresh March Higher in Oil Means for World Markets_4

Higher oil prices could feed dollar strength.

Bank of America said that while it remained negative on the dollar over the medium term, elevated oil prices meant the U.S. currency had "upside risks".

That exacerbates pressure on economies such as Japan battling currency weakness, keeping traders nervy over possible intervention to support a yen languishing at 34-year lows.

"The yen and the euro will see their terms of trade worsen as energy prices rise. This implies they will be weaker if energy prices rise," said Mizuho Corporate Bank senior economist Colin Asher.

Fresh Em Pain

Higher for longer oil prices will also sting many emerging market economies, such as India and Turkey, that are net oil importers.

India's rupee hit record lows against the dollar this week. What The Fresh March Higher in Oil Means for World Markets_5

With oil priced in dollars, many importers are also exposed to higher prices caused by currency fluctuations.

Even in Nigeria, typically Africa's largest oil exporter, a plunging naira currency has hit government coffers due to capped gasoline pump prices and a lack of local oil refining.

Source: Yahoo

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Central Bank

Economic

The market is digesting both the latest geopolitical developments and the recent rally in oil prices as the countdown to the May 1 Fed meeting has begun. Compared to the start of 2024, fewer rate cuts are expected by the key central banks with the market also contemplating a non-negligible possibility of the Fed keeping its rates unchanged during 2024.

Fed and the ECB: divergent paths

The initial market expectations of around six rate cuts in 2024 for both the ECB and the Fed were quite puzzling considering the perceived health of these two economies. The economic divergence between the US and the euro area has since become more pronounced as Chinese growth continues to disappoint and despite some very tentative positive signs from the euro area business surveys.

The Fed is seen cutting its interest rates by 42bps in 2024, which translates to one full 25bps rate cut and a 68% chance for a second rate cut of similar magnitude. The first rate cut is priced for November, clearly reflecting the recent trend in US data releases. With growth expected to stay north of 2% for the first quarter of 2024 and inflation remaining elevated, there is a strong possibility that the first Fed rate cut could be pushed out even further. Also, the November elections are gradually coming into the picture, complicating the Fed's position.

On the flip side, the continued economic growth weakness and the sizeable easing in inflationary pressures in the euro area have opened the door to the market pricing in three ECB rate cuts of 25bps each in 2024. Market Continues to Price in a Plethora of Rate Cuts for 2024_1

Market Continues to Price in a Plethora of Rate Cuts for 2024_1

BoC: two rate cuts and room for more

The Bank of Canada is probably the most dovish central bank at this juncture. The significant progress made in inflation was acknowledged in the most recent BoC gathering with Governor Macklem talking about the need for further evidence of a sustainable easing inflation. When examining the domestic issues, especially the housing sector, one could say that the two rate cuts currently priced in are probably an underrepresentation of current situation and hence more rate cuts could be announced in 2024.

BoE, SNB, RBNZ: one rate cut and done for 2024?

These three diverse central banks are probably going to announce at least one rate cut in 2024. The UK continues to experience high inflation and a relatively low growth rate. Bank of England members are preparing for the much-touted rate cuts, but the threat of renewed inflationary pressures, on the back of the latest geopolitical developments supporting the recent oil price rally, is keeping them up at night.

The year started with the market expecting almost four rate cuts by the Reserve Bank of New Zealand in 2024. Similarly to other central banks, inflation is proving stickier even though recent data is pointing to a weakness in consumer spending. Somewhat surprisingly, the RBNZ maintained its hawkishness at the recent meeting and poured cold water of dovish expectations. The market expects only 33bps of easing in 2024.

The Swiss National Bank surprised the market with its March rate cut. The low inflation forecasts for both 2025 and 2026 could mean that the SNB is not done yet. Hence, the market is currently fully pricing in another 25bps rate cut by September with around 56% chance of one additional move by year-end.

RBA: could it keep rates unchanged for 2024?

The Reserve Bank of Australia was the last one to hike in 2023 and the market is only assigning a 64% probability for a 25bps rate cut in 2024. Such a move though could become even more improbable if China finally manages to return to growth, influencing its main trading partners and the commodity markets.

BoJ: the market wants more

The first rate hike since 2007 has opened the market's appetite for further rate moves, which matches Governor's Ueda current thinking. The market is pricing in at least another two 10bps rate hikes in 2024 with the current yen weakness, and its impact on imported inflation, potentially offering the Bank of Japan an excuse to do even more down the line. Market Continues to Price in a Plethora of Rate Cuts for 2024_2