Risks of global recession are increasing. The conflict involving Iran – and the resulting disruptions to shipments of energy and other goods through the Strait of Hormuz – has now entered its fifth week. Global markets have remained relatively calm, despite shipping disruptions that threaten about 20% of the world’s energy supply. This share reflects the volume of oil and energy products that typically flow from Middle Eastern producers to global import markets across the strait. Tiffany Wilding, PIMCO Economist and Andrew DeWitt, PIMCO Portfolio Manager highlight this by explaining that although markets continue to price in a resolution in the near term and high levels of global inventories temporarily offer some protection to economies, economic costs are likely to increase as disruptions continue. The risk is that the markets, initially focused on the temporary inflationary effects of the crisis – and which have already priced in a tightening of monetary policy in the interest rate markets of developed countries – will soon have to deal with an increase in the risks of global recession and a destruction of demand, with negative impacts on stocks and credit and an increase in the premium recognized on bonds as safe haven assets.
An unprecedented interruption
A disruption of 20% of global oil supply would be unprecedented in modern history. For context, the decline in global consumption of oil and energy products during the peak of COVID-related lockdowns was also around 20%, according to OECD data. Over the same period, in the first half of 2020, global GDP contracted by more than 10% on an annualized basis. Both global GDP and oil consumption then recorded a rapid recovery as economic activities reopened.
Other notable historical episodes include the Arab oil embargo and Iranian revolution in the 1970s, which resulted in global output contracting by between 5% and 7%, according to the International Energy Agency, coinciding with recessions in the United States and sharp slowdowns in global growth. The Gulf War in the early 1990s also resulted in an 8%-10% disruption to production, with real GDP growth in OECD countries falling from 3.6% to 1.4%.
Markets oriented towards rapid resolution
What explains the relative calm of global financial markets? One plausible explanation is that operators are expecting temporary disruptions. The prices of oil futures contracts reflect this expectation: compared to a spot price of around $125 per barrel in the North Sea (“dated” Brent), contracts for delivery in December 2026 trade around $80 per barrel, showing a significant discount. Furthermore, before the conflict the world had ample supplies of oil, which are temporarily softening the impact of the disruptions. It should also be underlined that the storage capacity in the Middle East has allowed production to continue despite transport difficulties. Of the approximately 20 million barrels per day that transited the strait, just over 10 million are currently blocked in terms of production, while the rest continues to be produced and accumulated in deposits.
Increasing risk of a prolonged supply shock
Expectations of a quick resolution, coupled with these economic “buffers,” have so far limited the tightening of financial conditions. However, these reserves are not infinite: as the conflict and the closure of the sea route continue, markets will increasingly have to ask themselves when the situation will transform into a true negative supply shock, and no longer into a simple redistribution of income between energy producers and consumers.
Logistical timing is crucial: with the last tankers leaving the Strait of Hormuz at the end of February, cargoes are only now arriving at their destination. It takes about 10-20 days to reach Asia, 20-35 days to Europe and Africa, and 35-45 days to the US Gulf Coast.
Stockpiles exist but are unevenly distributed and the quality of the data – especially for China – is limited. According to the IEA, inventories in OECD countries could cover around 140 days of demand at last year’s levels, but with strong differences: some countries, including Mexico, Australia, Ireland and the United Kingdom, have less than two months of autonomy.
India and Australia are already taking measures to address possible shortages, while Asian refiners are preemptively reducing production to manage the situation. Meanwhile, storage capacity in the Middle East is rapidly running out. With production already reduced by around 10 million barrels per day and remaining capacity estimated at between 150 and 300 million barrels, the available margin covers only two to three weeks before further production cuts become inevitable.
Macro implications: recessionary risk
Some producers have partially diverted flows via pipelines, but time is limited. Furthermore, once production is stopped, it cannot be restarted quickly – it can take weeks or months. Increasing production outside the Middle East will require time and appropriate pricing conditions. In the United States, for example, a forward price of WTI at around $70 per barrel does not appear sufficient to incentivize a significant increase in shale production in such an uncertain context.
Economic policies have limited margins. Monetary policy is constrained by high inflation, while fiscal measures such as fuel price controls risk being counterproductive. Given a 20% global supply shock, prices would rise enough to compress demand by the same amount, effectively implying a recession. Interventions that limit price adjustments risk amplifying imbalances and burdening public finances.
Conclusions
Although the picture remains highly uncertain, with each passing week the economic costs of the conflict with Iran increase. As inventories erode, the effects of persistent disruptions may soon intensify, with recessionary implications for the global economy. Energy shortages, initially concentrated in Asian industry, could ripple through global supply chains, generating widespread shortages and cost pressures. In the absence of de-escalation, economic policies will have limited effectiveness and financial conditions could tighten significantly.
While markets continue to price in a scenario of temporary disruption, the risk is that they will soon be faced with the prospect of a more prolonged conflict and much higher economic costs.
