Morgan Stanley’s Michael Zezas (Head of US Policy) discusses the potential implications of an environment of geopolitical uncertainty, and where there is the potential for more countries to become involved in the recent open conflict in the Middle East. Although he acknowledges that there may be further consequences that are very difficult to predict, he highlights three conclusions where conviction is highest:
1.- Increased spending on Security => European and American companies are expected to spend $1.5tr on protecting their value chains: restructuring their supply chains to reduce foreign dependence and thus improve security. In this sense, he sees equipment suppliers as the main beneficiaries of this dynamic.
2.- Potential oil supply disruption => Concerns about inflation and consumption are inevitable as higher oil prices translate into higher gasoline prices. However, Michael points out that the effect of an oil price spike on goods and services is more limited and slower than thought: in previous oil supply shocks; a 10% price spike added +35bps to headline inflation (CPI) in 3M, but only +3bps to core (over the same time). Therefore, while higher gasoline prices would have a negative impact on consumption (especially of lower income households), weakening aggregate demand, a rebound in oil prices would not necessarily lead to a more hawkish view from Central Banks.
3.- EM credit risk premia spike => EM credit is not fully discounting the impact of geopolitical tensions, so Michael believes we should see a spike in MENA credit risk premia given the very tight starting point for spreads, although he notes that contagion effects to the rest of EMs should be limited. However, the tail risk for MENA credit (in particular) and EM sovereign credit (to a lesser extent) is an escalation of tensions leading to a disruption in the oil market, which Michael warns is not priced in.
