The optimism that briefly buoyed global markets last week has vanished as traders firm up rate hike bets for major central banks following the collapse of the US-Iran peace talks in Islamabad this weekend. The breakdown of negotiations has reignited fears of a protracted conflict, ending the fragile hope that a resolution was within reach.
WTI crude oil surged back above $100 today and Trump’s announcement of a naval blockade on Iranian shipping through the Strait of Hormuz could keep prices elevated for longer. This is keeping inflation worries at the forefront of traders’ mind as a prolonged conflict and elevated energy prices could creep into broader consumer goods and services.
The major central banks are in a hard neutral stance at the moment but they have opened the door for rate hikes. The problem is that a supply shock cannot be fixed with monetary tightening, which works on the demand side. In this context, rate hikes could exacerbate the slowdown in economic activity and even lead to a recession.
Policymakers have emphasized that their decisions will remain data-dependent, yet the market has been quite sanguine on multiple rate hikes by the end of the year. The duration of the war has become the primary variable. As the conflict enters its second month with no diplomatic exit in sight, the risk of stagflation increases by the day.
This article was written by Giuseppe Dellamotta at investinglive.com.