Energy Shock, Stagflation Risk & Defensive Positioning
The war in Iran escalated further in March with major disruption across the Middle East.
Brent Crude prices increased to close to $120 per barrel because of the closure of the Strait of Hormuz. How do you see the situation in the Middle East and the energy shock evolving?
Uncertainties are high. We have the conflict that is spreading into additional fronts, including, ground operation. And we have the net hits to global oil stocks estimated at around 13 million barrels per day. If we include the pipeline redirection and also the release of strategic oil reserves. So we have, for the moment limited signs of concrete peace talks between the US and Iran and the interests between the two countries are really diverging. The probability of prolonged oil and energy disruptions has risen further.
Given all the uncertainties and the dislocation on the energy markets, how is this translating into a macro scenario specifically on the inflation and growth front?
First, the energy disruption has led to an increase in energy prices. And this increase in energy prices is spreading to other sectors. For example, we have an increase in food prices through transportation costs or fertilizer costs. And this is also spreading to manufacturing costs. For now we are at a crossroads. Depending on the duration of these conflicts. The Goldilocks scenario is not our baseline scenario anymore. We increased substantially the probability of a stagflation scenario. And this is a scenario implying higher growth, higher inflation and more hawkish central banks. And for example the Fed, the ECB, the Bank of England, they already shifted their communication towards a more hawkish tone. But we think for now that the recession risk is limited.
So we have a very negative mix of high inflation, weaker growth plus geopolitical threats. How should we position portfolios today in this environment?
Persistant stagflation risks warrant a cautious stance on markets. Stagflation risks are headwinds for both equities and bonds. So in the beginning of the conflict we reduced our equity positioning to underweight. And after that we progressively continued to reduce. So we are underweight notably emerging equities and European equities. We also continue to reduce our sovereign bond positioning across all currencies. Because a monetary policy conduct is constrained for central banks now. The resolution in energy disruption is key for any market reversal. And once we have this resolution, cash upgrades will constitute key opportunities.
With heightened geopolitical risk and a lot of uncertainty on the macro side, we think that prudence matters. Reduce risk. Higher cash buffers. Selected exposures and redeploy later in the cycle will define portfolios for the coming months.
