The escalation in the Middle East has driven Brent to highs not seen since May, while the Fed and the ECB face key meetings next week. The group of economists at Schroders presents scenarios that could alter inflation, growth, and interest rates
Financial markets face a new source of uncertainty with the rise in oil prices amid escalating tensions in the Middle East. Brent reached $114.72 per barrel this Friday, its highest level since May 4, amid fears of energy supply disruptions. The evolution of crude coincides with a key week for monetary policy: the Federal Reserve of the United States (Fed) meets on October 27 and 28, and the European Central Bank (ECB) on the 28th and 29th.
In this context, the Group of Economists at Schroders, source of DEMÓCRATA, identifies five risk scenarios that could alter the outlook for inflation, growth, and financing. Among them are oil at $150 per barrel, a loss of confidence in the Federal Reserve, a U.S. intervention to limit long-term debt yields, and two opposing outcomes for artificial intelligence: an extraordinary boost to productivity or the bursting of a stock market bubble.
These are not central forecasts nor events that the manager considers certain. They are hypotheses that allow for analysis of how the economy and markets would react if certain disturbances occurred. The energy scenario gains relevance due to the recent rise in crude, but the five risks respond to different dynamics and do not have to materialize simultaneously.
Oil at $150 reopens the risk of stagflation
The first of the scenarios contemplates a new escalation of tensions in the Middle East that drives the price of oil up to $150 per barrel. The increase in energy costs would transfer pressure to fuel prices, transportation, and industrial production, as well as raise costs for sectors dependent on fertilizers and other energy derivatives.
The result would combine higher inflation and lower growth. Households would lose purchasing power due to the increase in energy prices, while companies would have to face higher production costs. If the shock were to prolong, the pressure could extend to food prices and hinder the recovery of activity.
Net energy importing economies, including the eurozone, the United Kingdom, and Japan, would be especially exposed. The increase in oil purchases would deteriorate their trade conditions and divert a larger portion of income towards exporting countries.
Central banks would face a dilemma: to maintain or tighten monetary policy to contain inflation when economic activity weakens. In Schroders' hypothesis, if the recession were to solidify during the fourth quarter, rate cuts could come from the second half of 2027. That timeline is part of the scenario posed by the manager, not of a confirmed forecast about upcoming monetary decisions.
The rise of Brent above 114 dollars during Friday's session gives relevance to this hypothesis, although it is still below the 150 dollars contemplated in the extreme scenario. Reuters attributed the advance of crude to concerns about possible supply disruptions following the worsening of Houthi attacks in Saudi Arabia and tensions in strategic routes for oil transportation.
The credibility of the Fed, under pressure
The second risk is concentrated in the United States and in investors' confidence in monetary policy. Schroders suggests that a review of the Federal Reserve's framework could lead the Federal Open Market Committee (FOMC) to implement fewer rate hikes than the markets expected, even if inflation remained high.
If investors interpreted that response as a lesser determination to contain prices, they could demand an additional yield for holding long-term bonds. That compensation would translate into an increase in term premiums and could raise the yields of U.S. public debt, even if official rates did not rise in the same proportion.
The result would be an adverse combination of persistent inflation and economic slowdown. In Schroders' scenario, the loss of confidence would put downward pressure on U.S. assets and the dollar. A recession in the fourth quarter would then reduce demand and help moderate the price of oil.
The FOMC meeting on October 27 and 28 will be an immediate reference for investors. A Reuters survey published on October 21 indicated that almost all economists surveyed expected the Fed to keep rates unchanged at its October meeting, although most anticipated a new increase in December. This market expectation is distinct from Schroders' hypothetical scenario and should not be confused with a decision already made.
The central issue is the credibility of the institution: if markets doubt its commitment to price stability, the long-term financing cost may increase even without an equivalent tightening of official rates.
Washington intervenes in the debt market
The third scenario contemplates an intervention by the U.S. Treasury to fix the yield on 30-year bonds at 4% through a mechanism to control the yield curve. This is a hypothesis from Schroders, not a measure announced by the U.S. government.
In principle, limiting the yield on long-term debt would relax financial conditions and could provide a moderate boost to growth. However, the outcome would depend on the reaction of investors and, in particular, on foreign holders of U.S. debt.
If they reduced their exposure to the country's assets, capital outflows could put downward pressure on the dollar and raise inflation through the increased cost of imports. The intervention would lower financing costs in the affected market, but it could undermine confidence in U.S. assets and generate effects contrary to those sought.
In the scenario posed by Schroders, part of the capital flows would head towards other economies. The appreciation of their currencies and more favorable financial conditions could support growth outside the United States without generating inflationary pressures of the same intensity.
The rise of AI may boost growth and displace jobs
The last two scenarios focus on artificial intelligence, but they draw opposite outcomes. In the first, the rapid adoption of this technology triggers a period of solid growth thanks to the increase in business investment and productivity.
The expansion of AI would require new investments in data centers, equipment, and infrastructure, with an increase in capital spending and energy demand. At the same time, automation could displace workers from certain activities, raise unemployment, and weaken household consumption.
The paradox is that a more productive economy does not guarantee that all sectors benefit equally. Efficiency improvements can expand productive capacity, but the effect on demand will also depend on how gains are distributed and how quickly the labor market absorbs the changes.
In Schroders' hypothesis, productivity improvements and moderation of consumption would offset the inflationary pressures associated with the increase in energy demand. The result would be more intense growth without a proportional rise in prices.
The stock market crash of artificial intelligence
The fifth scenario presents the opposite outcome: a sharp correction of the prices linked to artificial intelligence when investors begin to doubt that companies can turn the high current expectations into sufficient profits.
The adjustment would not be limited to technology companies. If companies reduced their investment plans, the contraction in spending on capital goods could extend to other sectors. Stock market declines would also deteriorate the confidence of investors and households, while the increase in unemployment would weaken consumption.
Schroders contemplates that the decline in investment and demand would push the United States toward a mild recession. The lower activity would relieve inflationary pressures and give the Federal Reserve room to cut interest rates, which could subsequently contribute to a recovery driven by consumption.
The risk does not only reside in a fall in prices. It also matters how much investment decisions and growth expectations depend on AI companies managing to monetize current spending. A disappointment in results could provoke a simultaneous revision of stock valuations and business plans.
Inflation, financing, and confidence, the critical points
The five scenarios identify different pathways through which a disturbance can be transmitted to the overall markets. An energy crisis could keep inflation high when growth loses strength. A loss of credibility of the Fed would raise doubts about price evolution and the cost of long-term debt. An intervention on U.S. bond yields would test investor confidence, while a boom or a correction in AI would have consequences on productivity, investment, and employment.
The responses of central banks and governments would be decisive for the extent of each shock. The duration of the disturbances would also matter: a temporary increase in oil prices would not have the same effects as a prolonged supply disruption, just as a stock market correction would not necessarily have the same consequences as a lasting halt in technological investment.
The analysis by Schroders does not present these scenarios as its central forecast nor does it imply that they will occur jointly. Its utility lies in showing how geopolitical, monetary, and technological risks can modify inflation expectations, corporate profits, and international capital flows. The evolution of oil and the decisions of the Fed and the ECB during the next week will provide new references to assess the economic environment, without confirming any of the proposed scenarios by themselves.