With Morgan Stanley joining Goldman and calling for $100 oil, and Bank of America's commodity strategist Francisco Blanch one-upping both, and today laying out the case for $120 oil...
... on Friday afternoon JPMorgan trumped all of its banking peers with a report that is especially troubling if not so much for the implications from its "theoretical" modeling, but for the fact that Wall Street is now actively assessing what may be the start of World War 3.
In a note from the bank's economists Joseph Lupton and Bruce Kasman (available to pro subs) which picks up where our article "Shades Of 2008 As Oil Decouples From Everything" left off, JPM writes that oil shocks have a long history of driving cyclical downturns, with US recessions often associated with oil price spikes...
... most recently of course the surge in oil to all time highs in 2008, which some say sealed the fate of the global financial crisis.
So looking at the latest geopolitical tensions between Russia and Ukraine, JPM warns that "these raise the risk of a material spike this quarter." That this comes on the back of already elevated inflation and a global economy that is being buffeted by yet another wave of the COVID-19 pandemic, JPMorgan sees the risk of a kinetic war breaking out as adding "to the near-term fragility of what is otherwise a fundamentally strong recovery."
Drilling down, JPM considers a scenario in which an adverse geopolitical event between Russia and Ukraine materially disrupts the oil supply. This scenario envisions a sharp 2.3 million b/d contraction in oil output that boosts the oil price quickly to $150/bbl—a 100% rise from the average price in 4Q21.
Given that this would be solely a negative supply shock, the impact on output is to reduce global GDP by 1.6% the bank calculates based on its general equilibrium model. And with global GDP projected to expand at a robust 4.1%ar in 1H22, the economist due project that "this shock would damp annualized growth to 0.9% assuming the adjustment takes place over two quarters. Inflation would also spike
to 7.2%ar, an upward revision of 4%-pts annualized."
It gets worse: in addition to the drag from a sharp contraction in oil supply our models estimate, there are two other channels through which this shock could damage global growth.
- The first relates to the repercussions of a Russian intervention in Ukraine. The US, coordinating with allies, would likely impose sanctions on Russia. While the possibilities vary widely in scope, they will likely impact negatively on sentiment and global financial conditions.
- Second, JPM estimates incorporate the realized behavior of major central banks over the past two decades whereby oil price shocks associated with geopolitical turmoil have been perceived to pose a greater threat to growth than inflation.
Against the backdrop of a year of already elevated inflation and extremely accommodative policies, JPM warns that central banks may display less patience than normal—particularly in the EM, where rising global risk aversion may also place downward pressure on currency values.
To be sure, as with any Wall Street analysis that models war, JPM is quick to caveat its findings, noting that "it is important to recognize that the scenario of a jump in the oil price to $150/bbl is premised on a sharp and substantial shock to the oil supply. History has proven that such large and adverse shocks do material damage to the macroeconomy. In this regard, the results reported here should not be a surprise but seen as useful for quantifying the damage based on a carefully specified general equilibrium model using generally accepted elasticities."
Boilerplate language aside, what is notable is that for months we have been wondering what "latest and greatest" crisis will replace covid as the "green light" that central banks and governments need to perpetuate not only QE and NIRP, but also the all important helicopter money. Now we know.