Rising oil prices remain the top concern for global investors

Investing.com - Morgan Stanley economists warn that the main risk facing global investors is not further spikes in oil prices, but the possibility that prices could remain elevated for a prolonged period.

The team, including Seth Carpenter, explored a scenario in which tensions around the Strait of Hormuz ease but are not fully resolved, leading to partial constraints on oil flows, leaving oil prices to “carry indefinitely a sustained geopolitical premium.”

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In this environment, the traditional dynamics of past oil shocks will no longer hold. Previously, after prices surged sharply, they would also quickly fall back, limiting the time for inflationary pressure to build up. But this time, with little expectation of mean reversion, businesses will face a prolonged cost shock and their ability to absorb it through profit margins will keep weakening.

The economists wrote: “Therefore, although the headline inflation data has improved, inflation risks remain skewed to the upside.”

On growth, Morgan Stanley does not expect a global recession. Instead, persistently high energy costs will weigh on consumption and corporate profit margins in both developed and emerging markets.

The economists said: “Economic slowdown may take time to show, but the impact will be very significant. However, because we believe this scenario will not lead to a global recession, second-round effects will dominate any disinflation impulse caused by the growth slowdown.”

They added: “Therefore, this shock is stagflationary in direction, and policy will tilt toward one side.”

Morgan Stanley believes that policy responses across countries will show marked divergence. The European Central Bank and the Bank of England, which are considered more sensitive to inflation expectations, are thought to lean toward further tightening.

On the other hand, the Federal Reserve is more likely to pause. The economists expect the Fed to “rule out the possibility of rate cuts in the near term, and indicate that it is willing to keep restrictive policy in place through 2027, especially if inflation expectations show signs of drifting.”

Fiscal policy is the area with the most pronounced divergence, especially in emerging markets. Governments that take broad price-suppression measures—fuel tax exemptions, price caps, or blanket subsidies—shift costs from households to public balance sheets.

The economists noted: “While this provides near-term relief, it weakens price signals, supports demand, and may keep inflation elevated.”

Energy-importing emerging markets with limited fiscal space face the harshest trade-offs, while energy exporters benefit from improved terms of trade and, in some cases, can also gain additional fiscal revenue.

Overall, the economists believe that “the persistence of the shock is just as important as the peak, and will drive the macro narrative.” Broad, untargeted energy support may keep inflation in check and force monetary policy tightening, while allowing price pass-through through narrower support implies weaker growth but more controllable inflation.

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