CICC has released a research report stating that the recent escalation of the situation in Iran and the renewed rise in crude oil prices have further intensified concerns about stagflation in the US and European economies. Last week, during the "super central bank week," the Federal Reserve, the European Central Bank, and the Bank of England collectively signaled a hawkish stance, prompting investors to significantly revise their expectations for the monetary policy path. Futures markets now imply that the timing of the Fed's interest rate cuts has been pushed back to the second half of 2027, with some expectations for hikes even emerging for 2026. Similarly, expectations for rate cuts by the ECB and the BoE have reversed to expectations for hikes. The policy choices of central banks amid oil price shocks are a core issue for current global asset pricing. CICC believes there may be a significant expectation gap in market pricing.
CICC's main views are as follows:
The importance of the current oil price shock for Fed policy decisions may stem more from financial market fragility than from stagflation risk. Although the macroeconomic impact of oil prices has structurally weakened and current inflation expectations in the US and Europe are not significantly out of control, geopolitical uncertainty can still reduce market liquidity and risk appetite, leading to a noticeable tightening of financial conditions. According to Ben Bernanke's "financial accelerator" theory, a deterioration in financial market conditions can have a significant negative impact on the economy. Particular attention should currently be paid to the risk resonance between US AI software and private credit, potentially causing a double whammy. US Treasuries are traditional safe-haven assets; their yields would typically fall after a geopolitical conflict. However, the 10-year US Treasury yield rose to 4.3% following the Iran conflict, indicating a marked decline in their "safe asset" attribute. Furthermore, geopolitical conflicts can suppress risk appetite, potentially amplifying the fragility of highly-valued US financial assets. Over the past two years, a dramatic structural change has occurred at the individual stock level in the US market, yet the index volatility (VIX) has remained low, underpinned by the "creative destruction" of traditional companies by new enterprises amid the AI revolution. Since 2026, the narrative of AI's "disruptive innovation" has intensified, leading the market to re-examine the business models of US AI software companies. The AI software sector is highly intertwined with the US private credit industry; nearly 30% of direct lending by Business Development Companies (BDCs) in the US private credit space is directed towards the technology sector. A shift towards tighter policy at this juncture could subject the US AI software industry to dual pressures on cash flow and valuation, significantly impacting the AI bubble and the private credit industry. From this perspective, even if a sharp rise in oil prices may not substantially impact the macroeconomy, the financial risks potentially triggered by declining risk appetite remain a crucial factor the Fed must consider in its policy decisions.
Monetary policies in China, the US, and Europe may ultimately trend towards easing this year, but the degree of easing could diverge. Geopolitical issues cause supply shocks, leading to simultaneous inflation increases and growth slowdowns, presenting central banks with a dilemma between "stabilizing growth" and "controlling inflation." Given the lagged effects of monetary policy, if supply shocks only temporarily push up price levels without altering the long-term inflation trend, premature or excessive reactions could exacerbate macroeconomic volatility. What determines the success of monetary policy in responding to supply shocks? The key may lie in whether oil price increases trigger a "second-round effect." The initial effect of rising oil prices is an increase in energy prices within the consumer basket. The second-round effect involves oil price changes leading to increases in core prices, such as non-energy goods, services, and wages. The strength of the second-round effect is influenced by the intensity and duration of the conflict, the state of inflation, inflation expectations, and labor market conditions. Once a central bank has established credibility, it can adopt the "Attenuation Principle" and essentially "look through" short-term oil price fluctuations, provided they do not cause a significant second-round effect. Monetary policy only needs to weigh the trade-off between stabilizing inflation and stabilizing output when oil price volatility affects other prices like wages and services. Currently, inflation expectations in China, the US, and Europe are not significantly out of control, and economic supply and demand are relatively balanced, suggesting the risk of a second-round effect remains limited. If the geopolitical situation does not escalate further, CICC expects monetary policies in China, the US, and Europe will ultimately trend towards easing, with a low probability of widespread interest rate hikes by global central banks.
China's supply chain holds relative advantages, its energy structure is more diversified, and it possesses ample strategic reserves, giving it relatively stronger capacity to cope with rising crude oil prices. In a low-inflation environment with subdued inflation expectations, insufficient domestic demand remains the primary concern. When household and corporate income budgets are constrained, rising oil prices increase energy expenditures, crowding out non-energy spending, akin to a "tax hike." Under these circumstances, monetary policy should not tighten passively merely due to oil price increases. Instead, it should coordinate with proactive fiscal policy to provide a counteracting effect similar to a "tax cut." Currently, external supply shocks from global energy price volatility objectively provide a window to boost inflation expectations. If fiscal and monetary policies can coordinate and act顺势而为, it could not only help break the "low inflation" negative feedback loop but also potentially transform cost-push imported inflation into a demand-supported moderate reflation. Considering that China's absolute inflation level remains relatively low, there are fewer constraints for implementing counter-cyclical adjustment policies, allowing for more ample operational space. It might be advisable to consider适时加大逆周期调节力度 in response to changes in internal and external conditions, to better promote expectation stabilization and domestic demand improvement.
Rising oil prices may increase the risk of "temporary stagflation" in the US. However, as the US became a net exporter of crude oil starting in 2019, and with the current US headline CPI year-on-year at 2.4%, already near the policy target, the core risk for the US from oil price shocks lies not in growth, nor even primarily in inflation. The real risk may be in the financial markets. Therefore, CICC expects the threshold for the Fed to significantly tighten monetary policy is high. If the conflict does not escalate significantly, the Fed might still resume rate cuts in the second half of the year, with a relatively dovish policy stance likely.
Although Europe demonstrated some energy resilience after the Russia-Ukraine conflict, it severely damaged European cohesion, exacerbated structural issues like wealth inequality, and was detrimental to long-term integration. Currently, European growth remains weak, and inflation is near the policy target; fundamentals do not support significant rate hikes. Given Europe's overall high external energy dependence, the risk of "temporary stagflation" may be higher than in the US. Operating under a single inflation target, the ECB may maintain a relatively hawkish stance.
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