Escalating geopolitical tensions, especially in the Middle East, could spark a new wave of global inflation that extends far beyond just rising crude oil prices, according to a recent report from Jefferies. The brokerage suggests that disruptions to shipping routes and vital supply chains could inflict more economic damage than current market expectations.
Broader Inflationary Pressures
In its latest GREED & fear report, titled "World War III and capex aversion," Christopher Wood, Global Head of Equity Strategy at Jefferies, stated that investors might be underestimating the significant inflationary risks stemming from prolonged geopolitical uncertainty. He noted that while artificial intelligence (AI) holds long-term deflationary potential, any substantial escalation in conflict would likely have an immediate inflationary impact.
The report emphasized that a major conflict would be inflationary initially, with continued disruptions to Gulf shipping lanes driving up costs across various sectors, not just energy. Jefferies highlighted that while markets primarily focus on crude oil prices as a gauge of geopolitical risk, inflationary pressures are more likely to emerge through higher costs for:
- Liquefied Natural Gas (LNG)
- Refined petroleum products
- Freight services
- Marine insurance
- Wider supply chain components
These pressures would be particularly evident to businesses in manufacturing, logistics, and trade, rather than solely to financial market participants focused on asset prices.
Bond Market Reflects Growing Concerns
Jefferies also pointed to recent movements in the US Treasury market as an indicator of increasing investor concern over geopolitical developments. The report noted that the 30-year US Treasury yield climbed to 5.22%, its highest since July 2007, and the 10-year Treasury yield rose from 4.61% to 4.68% in a short period. These increases coincided with uncertainty following the latest Federal Reserve meeting and heightened global tensions.
While long-term inflation expectations remain relatively contained, Jefferies argued that current geopolitical circumstances bear similarities to periods preceding major historical conflicts, suggesting a higher risk of persistent inflationary pressures.
Markets Question AI Spending
Beyond geopolitics, the report indicated that investors are beginning to reassess the massive capital expenditure plans announced by leading technology companies for AI infrastructure. Jefferies observed a sharp correction in semiconductor stocks and warned that markets are reacting negatively to rising AI-related capital expenditure, especially when it impacts free cash flow.
Alphabet and Meta, for instance, faced investor pressure after reporting weaker free cash flow alongside elevated AI spending, while Microsoft saw better performance after maintaining its capital expenditure guidance. Although it's too early to conclude a slowdown in hyperscaler AI investment, as earnings estimates for major memory-chip companies haven't been revised lower, the changing market reaction to higher capital expenditure is a crucial signal for investors to monitor in the coming months.