Is there too much room for doom and gloom?
Markets may be overpricing geopolitical risks as higher energy prices heighten concerns, but recession fears remain premature.
Since the U.S. and Israel attacked Iran on February 28, massive surges in oil and gas prices have dominated the headlines. A sense of doom and gloom is shaping the global outlook. For example, a media-savvy Swiss economist expressed fears of a global recession in an interview last Friday. There is no reason to panic, however, as economists tend to be wrong more often than right.
Of course, we don’t have a crystal ball, either. Given the current geopolitical situation, events could unfold negatively or lead to de-escalation at any moment. For example, Trump could consider the war over as he indicated and halt U.S. attacks. Oil and gas prices have reacted positively to this prospect, although securing the Strait of Hormuz remains virtually impossible as long as Iran does not back down. And production in the Middle East will be disrupted in the longer term in some cases, such as due to the Iranian strike on the Ras Laffan facility, which resulted in a 17% loss of Qatar’s LNG production.
However, only about 20% of the world’s oil and gas supply passes through the Strait of Hormuz, most of which is bound for Southeast Asia. While this disrupts the global supply in the short term, it does not truly threaten it at its core. Nevertheless, the impact on prices across the global market remains a cause for concern. For instance, even though Europe sources only 5% of its LNG from Qatar, it is suffering from the nearly 100% price increase because buyers in Southeast Asia, especially China and Japan, are purchasing all currently available LNG volumes at almost any price.
This price effect is causing great concern in the financial markets. On the one hand, it has a dampening effect on the economy. However, this does not mean that the economy will immediately plunge into a recession. The global economy’s dependence on oil prices is often overestimated, as the intensity of oil use has declined from 0.12 tons of oil equivalent per unit of GDP in 1970 to 0.05 tons. On the other hand, fears of inflation are rising. According to the Federal Reserve’s inflation model, a $10 increase in oil prices would push inflation up by approximately 0.35% if the increase persisted for more than three months. Markets are reacting sensitively to this risk due to interest rate transmission and the resulting threat of negative valuation effects. Last week, all central banks adopted a wait-and-see approach, and long-term interest rates rose.
This is a real concern. However, the stock market's reaction seems rather exaggerated. For example, since the outbreak of the war, the MSCI World Index has fallen by almost 10%.
Investor sentiment is at its lowest level in a long time. The CNN Fear & Greed Index, for instance, indicates extreme fear. In the past, this has often proven to be a buying opportunity. As Warren Buffett said: "Be fearful when others are greedy, and greedy when others are fearful."