Unpicking complex global growth dynamics

Key points

• Oil price shocks are now less likely to trigger recessions, although they still push inflation higher and slow growth.

• The impact varies by region: The US is relatively insulated, Europe faces slower but still positive growth, while Asia is more exposed to rising shipping costs.

• Inflation, not growth, is the key macro concern - reducing the urgency for aggressive monetary tightening.

Rising oil prices are once again in focus for global markets, yet the macroeconomic implications appear notably different from the oil shocks of 30 years ago. 

While higher energy costs still act as a driver of inflation and a drag on growth, the net result in the current environment is more nuanced – with growth remaining intact even as inflation trends meaningfully higher.

A familiar shock, a different outcome

Historically, energy price spikes have been closely associated with recessions. Today, however, the sensitivity of economic growth to oil prices has diminished. Structural changes, including improved energy efficiency, diversification of supply and a shift in the global economy towards less energy-intensive sectors, mean that higher oil prices no longer translate directly into broad-based economic contraction.

• This does not imply that the impact is negligible. For consumers, the effect is immediate: higher fuel costs reduce disposable income and can weigh on spending. Yet this pressure is unlikely to trigger a systemic downturn.

• Instead, the current dynamic points to a more modest drag on activity, alongside rising inflation. In other words, economies can continue to grow, albeit at a slower pace, while inflation remains elevated.

Idiosyncratic risks across regions

The impact of higher energy prices is far from uniform. Regional differences in energy dependence, supply dynamics and geopolitical exposure are creating increasingly idiosyncratic outcomes.

In the euro area, Vanguard has lowered its outlook for growth, which is now in the 0.5% to 1% range, in line with market consensus. While this marks a clear downgrade from earlier forecasts, it is not inconsistent with the region’s experience over the past decade, excluding the post-pandemic rebound. 

Growth remains positive, supported by stable energy supply and improved resilience compared with the energy crisis of 2022–2023, triggered by the start of the Russia–Ukraine conflict. Crucially, Europe’s energy system now appears less vulnerable to extreme price spikes, aided by greater contributions from nuclear and renewable sources.

The US presents a different picture. As a major energy producer, it is relatively insulated from higher global oil prices and may even benefit. As a result, the US economy continues to demonstrate strength, with little evidence of a material growth shock from rising energy prices.

Asia, by contrast, appears most exposed. Longer shipping routes are increasing both costs and uncertainty. In some cases, transit times have extended significantly, complicating supply chains and amplifying pricing pressure. For example, transit times for ships from Asia that previously took around 10 days via the Strait of Hormuz can now take up to 18 additional days via the Cape of Good Hope, South Africa¹. 

Where shortages emerge, we could see sharp price increases as energy buyers compete for limited supply.

Market sensitivity and geopolitical risk

Against this backdrop, markets remain highly reactive to geopolitical developments. Headlines around conflict escalation or potential resolution continue to drive short-term price movements, particularly in energy and rates markets. Investors are increasingly positioning portfolios to withstand potential shocks, with inflation hedges and interest rate expectations adjusting accordingly.

Despite macro uncertainty, corporate earnings have been robust, particularly in the US, supporting strong equity market performance. This resilience underscores the importance of distinguishing between cyclical headwinds and underlying corporate strength.

AI momentum

One notable support for global growth appears to be AI adoption. Company filings show that corporate capital expenditure is accelerating, with some estimates pointing to substantial increases in investment over the coming year. Importantly, early signs suggest that these investments are beginning to generate returns, alleviating earlier market concerns around overspending and potential bubbles.

This sustained investment momentum is helping to underpin economic activity, offsetting some of the drag from higher energy costs and geopolitical uncertainty.

Inflation remains the central question

If growth proves resilient, inflation is likely to remain the key macro variable. Headline inflation in major economies is expected to rise towards the 4% level in the near term, driven in part by higher energy prices. Crucially, economies now appear more tolerant of such inflation levels, reducing the urgency for aggressive monetary tightening.

• In the US, the market expects the Federal Reserve to maintain a cautious stance. While growth remains strong and inflation elevated, the threshold for further rate hikes appears high. Instead, the Fed’s focus has shifted away from imminent rate cuts, reflecting more robust labour market data and persistent price pressures.

• Europe faces a more complex challenge, with inflation primarily driven by energy costs rather than demand strength. However, improved energy supply dynamics suggest that price increases are likely to remain contained relative to the extreme spikes seen in recent years.

Portfolio implications of complex dynamics

Over the longer term, we believe that currency dynamics will be increasingly driven by energy fundamentals and the US dollar. Within FX, we are incorporating hedging strategies where appropriate across our active fixed income strategies. As we focus on the fundamentals, we look to express our hedges via underweight exposures to countries most affected by trade disruptions due to the current geopolitical situation. In this regard, we see the Indian rupee, Thai baht and Japanese yen as particularly exposed, and remain underweight these currencies relative to the US dollar.

Ultimately, while higher oil prices continue to matter, they no longer dictate the broad macro narrative in the way they once did. Instead, they form part of a more complex backdrop for investors to make sense of – one in which growth, inflation and policy responses interact in increasingly nuanced ways.

¹ Source: air7seas.com.