The desk argues that the ongoing geopolitical tensions, particularly the Middle East conflict, are creating significant discrepancies between market expectations and macroeconomic realities, particularly regarding growth and inflation. Per the full note source, Standard Chartered highlights that while markets are fixated on inflationary pressures, they are underestimating the potential for demand destruction across various economies. This misalignment could lead to a recalibration of central bank policies, particularly as inflation persists longer than anticipated, impacting discretionary spending and investment decisions.
What the desk is arguing
The desk posits that the current geopolitical climate is leading to a divergence between market sentiment and actual economic indicators, particularly in relation to inflation and growth. Standard Chartered's analysis indicates that while inflation is being felt immediately, the subsequent impact on growth may take longer to manifest, suggesting a potential underestimation of demand destruction in the markets.
Supporting this view, Standard Chartered notes that elevated commodity prices and disrupted supply chains are likely to lead to reduced discretionary spending. They emphasize that the impact of the ongoing conflict could lead to structural changes in commodity markets, with a potential increase in resource nationalism and a higher risk premium on global trade.
Where it sits in our coverage
Our consensus target for the EUR/USD is 1.075, with a range from 1.04 to 1.12. Specific firm targets include: - jpmorgan: 1.10 (Mar26) - bofa: 1.04 (Mar26) - citi: 1.12 (Mar26)
This view aligns with jpmorgan, which reflects a similar outlook on the impact of inflation on growth, while bofa sits at the lower end of the range, indicating a more cautious stance on the euro's strength against the dollar.
How other firms see it
Firms like citi and jpmorgan share a bullish outlook on the EUR/USD, anticipating that inflation will drive central banks to adjust their policies, thereby supporting the euro. Conversely, bofa maintains a more bearish perspective, suggesting that the euro may struggle against the dollar due to persistent economic challenges.
Key indicators to watch include the ECB's interest rate decisions and inflation data, as these will significantly influence the EUR/USD trajectory moving forward.
Key takeaways
01Geopolitical tensions are creating a disconnect between market expectations and macroeconomic realities.
02Inflation is being felt immediately, but the impact on growth may take longer to materialize.
03Demand destruction is a significant risk that markets are currently underestimating.
04Structural changes in commodity markets may lead to increased resource nationalism.
Market implications
Traders should monitor the EUR/USD closely, particularly around the next ECB meeting, as shifts in inflation expectations could lead to volatility. A break above 1.08 could signal a bullish trend, while a drop below 1.05 may indicate a bearish sentiment.
Hello, I'm Eric Robertson, Global Head of Research and Chief Strategist at Standard Chartered. And I'm Madhur Jha, Global Economist and Head of Thematic Research also here at Standard Chartered. Welcome to Macro Freestyle, our monthly podcast series where Madhur and I will identify and explore topics that are likely to be most impactful and relevant for financial markets and the global economy.
Thank you all for joining and welcome back to another episode of our podcast. It's been almost two months since the start of the Middle East conflict. So in today's podcast, which we are recording on the 21st of April, we are going to discuss the outlook for not just the global economy, but also financial markets and how the conflict has impacted that.
Eric, you recently published your updated strategy views. Has the conflict meant a significant change to your views compared to three months ago? The short answer is yes, it has changed my views about the outlook fairly significantly.
Although I think we have to add the qualifier that the markets seem to want to look through this crisis and seem to want to look towards the end result of a comprehensive resolution. But in terms of the change to the outlook, there's a couple of things that I think we have to focus on. The first of which is there's obviously going to be a hit to growth for the oil exporters in the Gulf.
The magnitude of that growth impact will depend on whether they are completely shut in terms of their energy production or whether they have alternative means of exporting their oil and gas and whether their economies have other sources of revenue. The second major economic impact that we see is for the importers around the world. There's a large focus on Asia in particular.
There are concerns about Europe now in terms of jet fuel supplies. But I think the economic impact on large parts of Asia that is in some cases 100% dependent on the Strait of Hormuz for their energy is something that we're very focused on. And I think even if we do get some conflict resolution or de-escalation in the short term, we believe that there will be a medium term economic impact.
Another way of talking about that is the economic scarring effect. The third factor is I think what this crisis has done is shown a light on those parts of the global economy that are structurally short of key commodity inputs, not just oil and gas, but whether it's fertilizer, whether it's helium, whether it's phosphate, I mean, you name it, everything from oil and gas to petrochemicals to plastics. This crisis is showing some real vulnerabilities in the global economy and the global supply chain.
And I think that's going to feed into a structural bid for the broader commodity complex. I think that may lead to more and more examples of resource nationalism. And I guess the final point I would make is that key transportation spots around the world being at risk in addition to the Strait of Hormuz is something that I think will require greater risk premium in how we think about global trade.
So yes, it has really had an impact on how we think about the forward outlook for the next three, six, and 12 months. And Eric, where in your view is the biggest divergence between what's happening in your global economic outlook that you've just painted versus where markets are currently trading and how should investors be thinking about that? If I had to describe the divergence in one expression, I would say demand destruction.
There's been so much focus so far on the inflationary impact, the price impact of the shortage of oil and gas and other commodities. Rates markets around the world were pricing in significant rate hikes across both EM and DM. But what I think the markets are completely ignoring at the moment is the potential for demand destruction in a number of economies around the world.
And the reason I say that is because if we have elevated oil, gas, electricity, commodity prices in general, if global trade has a higher frictional cost, ultimately there's going to be a real impact on discretionary spending and discretionary investment, both at the consumer level and at the business level. People are very concerned about stagflation, but I think there's a misunderstanding about how stagflation can come about. And what I mean by that is there's a timing mismatch.
As I've just alluded to, the inflationary impact is very much upfront, but I think the impact on growth to the downside can take a lot longer to play out. And so whether you're a consumer or a central bank, the reaction function to those higher prices plays out over a longer period of time. And when I look at equity markets, I think there is a categorical rejection of the idea that there's going to be a hit to growth or to profits.
And so I think that's where the greatest asymmetry lies. Now, we may get a resolution in the next few weeks. We may start to see a gradual reopening of the Strait of Hormuz.
But even if we do get that, it's still going to take several months at a minimum before we really get to a point of normalization. So I think that's how I would frame this disconnect that you're talking about. Madhur, let's turn to some of the broader macroeconomic issues.
In your opinion, are we already seeing the conflict have an impact on growth and inflation expectations or projections? You said how inflation is going to be felt first. And we've seen this historically, that any oil shock, any energy shock really comes through in your headline inflation numbers fairly quickly.
And the growth impact can be felt over a much longer period of time. And that's why for most parts of the world, we are seeing headline inflation numbers for the year being revised up. We are still kind of working through what's going to happen on the growth impact.
But there is the oil price shock, but there's also the actual disruption to the physical supply of oil, in particular for Asian economies. And that's already beginning to have an impact on activity for countries like India, Vietnam, Thailand. We have already lowered forecasts either because directly the oil supply disruption is having an impact or the price shock is already having an impact.
Or just maybe the disruption to trade and tourism is having an impact. The terms of trade shock is also having an impact on a broader range of Asian economies. It's not just the EM, but even for Japan, for example, we've lowered our growth forecast.
And I think we're going to see a broader set of countries outside of Asia, which are very dependent on fuel and food also being hit. Kenya also, we've lowered our forecast. Largely, we're seeing the inflation impact coming through first.
And as you mentioned, the reaction functions of central banks are going to be different. So while we might not be updating the growth forecast yet for some of the more developed markets, we've taken out things like expectations of rate cuts from the ECB, from the Bank of England. And that's really reflecting the fact that inflation is likely to be higher for a longer period of time.
Thanks, Madhur. And let's get a little bit more specific. The one country we haven't mentioned yet is China.
And that one's an interesting case study, because their Q1 growth data has come out and GDP growth was resilient. But we've also seen some examples of weakness in the data from things like demand for credit and some of the other aspects of consumer demand and consumer spending. But how should we be thinking about China's outlook going forward now and perhaps the impact on the rest of the world?
The Q1 growth numbers for China were very strong, stronger than market expectations. And that reflected both a very strong export performance as well as some stabilization of the domestic demand story. On the export side, it's really the new energy and the AI-related goods sectors which are doing very well.
In fact, China is the biggest exporter of AI-related goods in the world. And that's really driving the export growth story. On the domestic demand side, the fixed asset investments have picked up after a very weak Q4.
And we think that that can be partly attributed to the fact that there's been a front-loading of fiscal stimulus, and that's likely to continue to provide some support. Now, the Middle East conflict is likely to have more of an impact in terms of Q2 GDP growth data. But overall, because of China's improvements in energy efficiency and its reduction of the dependence on energy uses, China's a little bit more secure or less impacted by the conflict as compared to some of the other economies.
I think, though, that if the conflict continues for some time, the impact will be felt more in terms of the growth story as well. And that's why the authorities might want to keep some powder dry in terms of what support they can provide. So we might not see any extra fiscal or monetary stimulus coming through just yet because the economy is doing OK.
But we might have to wait to see what happens in Q2. Some of the more recent data has been weak, but we do think that partly that is a reflection of the Lunar New Year holidays and the base effects. Looking ahead, I think the biggest concern will be the fact that China's growth story still very much is dependent on its export growth performance.
And if you were to see an extended period of conflict starting to make other countries see weaker growth, then you are likely to see China's growth also starting to come under pressure because of weakness in its exports. And maybe, Eric, staying with China, do you see China's current relative resilience, meaning that the renminbi can be more of a challenge to USD dominance? Do you see an acceleration of the de-dollarization trend?
I think the outlook for China economically is mixed. I would agree with you that there are aspects of China's outlook that look very resilient, especially when compared with some of their regional peers. Q1 definitely had shades of a better story.
I suppose what I'm worried about is that if we really do see a hit to demand globally, the demand for China's exports could take a hit and then maybe the export machine, the persistence of this trade surplus, loses some steam. So I think there's a potential risk to growth if global demand experiences a shortfall. The second factor is that I'm not convinced that you will see an inflation impulse in China.
I think at best the inflation narrative becomes neutral. We go from deflation to something around zero or marginally positive. Now, that's not a bad thing, but it also means that with relatively subdued demand for credit, I think bond yields in China will remain relatively low.
Now, again, that may be a stabilizing factor, but I think we have to be conscious of the fact that this economy is still facing a number of domestic headwinds. Now, turning our attention to RMB, RMB has clearly been a low volatility currency throughout the crisis. It really stands out in terms of that stability factor.
And this at a time when currency volatility has picked up across both EM and DM, I think there is sympathy in the global marketplace for the idea that China's role and the RMB's role are growing and that this crisis in the Gulf has presented China and its currency, quite frankly, with an opportunity. Now, I'm a little skeptical, as we've discussed before, about the de-dollarization theme. I think the dollar depreciation that we are seeing right now is 100% driven by the improvement in risk sentiment in the markets.
That correlation looks rock solid to us. The idea that China's currency will replace the dollar as a result of this crisis or that this crisis accelerates that trend, I'm skeptical. We are seeing an increase or an improvement in RMB utilization worldwide, global trade, global settlement, et cetera, et cetera.
That's a good thing. That's a diversification of the global fiat system. Do I see RMB replacing the dollar in the petrodollar system?
Do we move from petrodollars to petro RMB? I don't think so. The reason I say that is even if some of the major oil exporters were to denominate some of their oil sales in RMB, they all still run largely dollar-based systems by virtue of their currency pegs to the dollar.
I don't see RMB upsetting that or unsettling that. The way I do describe it, though, is I think what we're moving towards is a system of parallel ecosystems. In other words, there will continue to be a very comprehensive dollar-based system for trade, for derivatives, et cetera, et cetera.
But I think there's an increasing role for RMB in that system. And I think there's an increasing role for China to engage with its trade partners and conduct trade and to settle trade in RMB. And our proprietary RMB Internationalization Index certainly supports that move.
And Eric, maybe coming back to the crisis, I wanted to pick up on something you said a little bit earlier, which was the economic scarring that's going to be a result of this conflict. How do you think that central banks should be thinking about economic scarring? And in particular, what would that imply for rates, markets, the yield curves?
So the first point that I would make is that I think central banks will try their very best to sit on their hands for as long as possible. We'll see the inflationary impact very much upfront, and then the growth impact to the downside will linger. And I think they want to be very careful that they don't tighten monetary policy prematurely or overly aggressively, and then risk an even worse hit to growth later on.
In terms of the economic scarring, I think there's a couple of ways to think about that. Number one, for those countries that we have previously described as the have-nots, I think the current environment will probably contribute to the widening of the gap between the haves and the have-nots. Those who find themselves structurally short of either energy supplies or other key commodities will again find themselves struggling to procure those much-needed supplies.
But then the final impact that I think about is the fiscal side. And I think it's clear to me, at least, that most governments will have to deploy more fiscal stimulus, more fiscal support for their economies in response to this crisis. And that's going to put more strain on the budget deficits.
It's going to put more strain on their sovereign balance sheet and will likely require more borrowing. Now, more borrowing in a world of stagflation, I think, means steeper yield curves. And that's a theme we've talked about before.
And the worst-case scenario, and I don't want to suggest this is a baseline view, but it is something we need to think about, is there is the potential for a negative feedback loop, where more fiscal, because of economic scarring, then leads to steeper curves, higher financing costs, putting further strain on fiscal balances, requiring more borrowing, et cetera, et cetera. And we get a negative spiral. Now, I don't think we're going to get there.
But if this crisis in the Gulf were to last for another six months, then you really start to see where the fiscal risk comes from. And I think that's something that markets are not pricing correctly at all. And that brings me back to this topic of trade, because trade concerns actually seem to have been relegated to the background in terms of the macro narrative that I see being discussed.
And do you see these trade concerns, whether it's because of tariffs or because of geopolitical friction, do you see that coming back as a driving force of the economic outlook this year? Yes, certainly. I think, Eric, we are going to see repeated episodes of rising trade concerns, given that there's a lot that is still unresolved in terms of the US administration's approach towards its trade partners.
Obviously, a lot has happened since then. But two months ago, the US Supreme Court basically shot down the use of IEPA for reciprocal tariffs that the US administration then had to use Section 122 to impose 10% tariffs on all trade partners. But this Section 122 can only be used for 150 days.
So the US administration has now opened several investigations under Section 301, Section 232 against trade partners. And we still have to see what the implications of those investigations are. Most representatives of the US administration are saying that they would like to take the tariff levels back to the IEPA tariff levels, which is much higher than where we are currently.
So there is the risk that you could see a lot more noise around this again towards the middle of this year. And especially, we've got the Xi-Trump summit happening in about a month's time. So there might be a lot more noise around trade around mid-May.
And we have to keep an eye on that. There's also the ongoing challenges to the use of Section 122 in the US Supreme Court. So right now, things seem to have reached a sort of uneasy calm on the trade front.
But given geopolitical tensions, given how trade routes are being impacted by the conflict, by shipping lines being disrupted, all of these will add up if you also have the tariff concerns coming back. Eric, you have been highlighting that we obviously have the energy shock, which will keep oil prices and energy prices elevated, but that we might have actually entered a new bull run for commodity markets, even aside of that. And can you elaborate on your reasons for thinking the same?
Yeah, sure. This concept is something I call resource nationalism. And what I mean by that is this crisis, as well as COVID, as well as the Russia-Ukraine conflict, has really highlighted that a number of economies have dominant or monopoly positions for certain key commodities, natural resources, or even more advanced products.
And that's everything from oil to rare earths to the industrial inputs that we need for making memory chips, you name it. This regional fracturing or the risk of choke points on the global map, to me, highlight this idea that we are moving into a world where countries who have real control over key commodities or key inputs are increasingly likely to use that control as a form of geopolitical leverage. Now, we've seen throughout history that countries use their control of these markets as a form of economic leverage.
But with the geopolitical landscape that we're in, I think the risk of that resource nationalism is growing by the day. And whether it's countries restricting exports only to those countries that are viewed as political allies or directing certain exports to certain countries for geopolitical reasons, we're seeing more of it. And I think the risk is that you move into a system where people are really thinking very, very carefully about how they source these key inputs and making sure that they're diversified, making sure that they have access to what they need.
I think the risk of resource nationalism is no longer an academic concept. I think it's real. And I think that is going to inject some frictional cost and some risk premium into commodity markets, which should keep a number of commodities more elevated than they otherwise would be.
So we've obviously got economic factors and geopolitical factors colliding here. But I think that's the name of the game for commodities for the foreseeable future. And Eric, another thing which might be puzzling to many in the market is usually gold plays a safe haven role during periods of heightened uncertainty.
But this time, gold prices have fallen. How would you explain this kind of breakdown of correlation? And can we expect to see gold weakness or do you think that there's going to be recovery from here on?
A short answer is I think we see a recovery, but I think we do need to understand why gold has not performed its traditional safe haven role. And by the way, I would highlight that the traditional portfolio of safe havens, including gold, including U.S. treasuries, including the Japanese yen, none of them have performed well in this crisis. But for gold specifically, I think the answer is relatively straightforward, which is that there was extensive long positioning in the gold market.
Investors were long, reserve managers and public sector institutions were long. And so as the crisis hit and there was volatility in the extreme in a number of asset markets, people liquidated some of their gold to take profits and to raise liquidity. For leveraged investors, the first few weeks of the crisis meant that due to volatility, many of them were forced to pay margin calls or to top up their margins with their counterparts.
And I think people sold gold to fund some of that liquidity raise. Now the good news is that I think most of that selling is done. I think the correlation between gold and risky assets is going to change again.
So I would actually expect that going forward, gold would start to perform much better. If people believe the themes that we've talked about today, which is economic scarring, financial scarring, resource nationalism, etc., all of those factors in my mind are very good legs of support for owning gold as a diversification asset. So we are constructive as a team on the gold price.
I think we'll probably head back to new highs at some point, but I think it's been an important exercise in understanding from a portfolio point of view, why traditional safe havens have not performed so well this time around. Thanks a lot, Eric. Thank you all for joining and hope to see you again next time.
Thank you for listening to Macro Freestyle, our monthly podcast series on all things macro. Please do join us again for next month's edition. This podcast is provided for informational purposes only.
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