Old Mutual Wealth Investment Strategist Izak Odendaal discusses the war-induced oil price shock and recalls the stagflation seen in the 1970’s, a period remembered as miserable for ordinary people, as likely to be repeated in today’s world.
War and oil have a long, bloody and tangled history. Wars have been fought over oil, and wars in turn have disrupted oil flows.
Prices have shot up as everyone wonders where the alternative sources will be found. And amid the uncertainty, equity prices have gone the other way. Since the start of the year, the MSCI All Country World Index has lost 12% in dollar terms.By mid-2008, a combination of strong demand growth from China and a pervasive “peak oil” narrative drove prices to a record $150 per barrel and played no small part in the devastating recession that was to follow.
Therefore, the extent of the shock is likely to be much smaller, and shorter-lived since Russian production can be replaced over time . Base effects took inflation lower in 1976 but by 1978 it was rising again. The 1979 Iran Revolution caused another oil spike and inflation shot up again. This time, it took Fed Chair Paul Volcker’s crushing interest rate hikes to cause a deep recession and finally break the back of entrenched inflation.
Among the major economies, the Eurozone is facing the biggest shock. For while oil prices have risen spectacularly, they look tame compared to the roughly sixfold increase in natural gas prices over the past year. Gas accounts for about a quarter of the total energy mix in the Eurozone, most of it coming from Russia.
Shortages of fertilizer – Russia is also a big supplier of fertilizer inputs – could impede planting today that will only show up food prices six months to a year from now. Supply chain disruptions – already a headache prior to the invasion – will likely intensify as Russia is effectively cut out of the global economy and financial system.
Given a strong US economy, companies there seem to have pricing power. Margins are close to historic highs. This suggests inflation can remain high as input costs are passed on to a degree. Globalisation, particularly the explosion of the global workforce following the implosion of isolationist communism, put downward pressure on costs and wages. This is not going to repeat at the same scale.
Yes, commodity prices are giving the total economy a boost – the jump in our export prices more than offset the increase in oil at a macro level – but for South African consumers conditions are tough, and fuel and food prices matter more than the palladium price. For Eskom too, the cost and availability of diesel is proving to be a constraint.
Therefore, the economy is unlikely to face an interest rate shock to compound the misery from higher fuel and food prices.
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