Inflation has been a primary challenge for central banks around the world. For the past several years, central banks have been raising interest rates to bring down levels of inflation, the likes of which we have not seen in over 40 years. We know inflation can destroy economies and there are many reasons it can persist, including too much money supply, supply chain issues, workers shortages, rising commodity prices, natural disasters and war.
Which brings us to the current situation in the Middle East, which has seen its share of conflicts over the years ranging from regional flare ups to global powers entering the region seeking stability or change, but often ending in greater instability. Recently, that instability has led to increased conflicts between Israel and Hamas. Further intensifying the situation are Houthi rebels backed by Iran attacking cargo ships in the Red Sea, threatening some of the most important shipping lanes in the world. This situation has shaken up the lower inflation scenario the Federal Reserve is relying on to begin cutting interest rates in 2024 and beyond.
While it remains to be seen how the tension in the Middle East will escalate, if at all, we have looked back through history to see how inflation has aligned with other conflicts to gauge how the current situation could impact interest rate outlooks. In nearly every previous major conflict, inflation has spiked considerably. We would expect that, if tension were to escalate further in the Middle East, this time would be no different. The explanation lies in the current region itself.
Approximately 12% of global trade, worth more than $1 trillion (about $3,100 per person in the U.S.) passes through the Red Sea every year, including about 30% of global container traffic. Should the Houthis or any other militants continue attacking container ships in the area, global supply chain interruptions like those we experienced during the COVID-19 pandemic could follow. If these interruptions were to persist, we would expect to see inflation pick up, forcing central banks around the world to change their narrative of lower rates and potentially replace them with raising rates again.
While the extent of the impact on the Middle East is highly uncertain, we know a larger scale conflict will present major challenges for the region and the world. So far, the impact on the financial markets has been limited. However, investors should be prepared for the possibility of tensions escalating in the region leading to greater volatility in the financial markets, including increased inflation. A well-diversified portfolio that is balanced with your risk appetite and longer-term return needs can help mitigate the impact of this scenario. For further information please contact your Ancora representative.
Author’s Note: Please note that here we discuss only the potential economic and market impact of these events, acknowledging that the physical and emotional toll has been far greater and that the situation is still developing. Our thoughts are with all those whose lives are affected by these events.