After a U.S.-led coalition conducted airstrikes against Houthi rebels in Yemen this week, the stakes are raised - as are the risks of inflation remaining stubbornly high.
Stagflation is the emergence of rising inflation during an economic downturn - it's not common, as weak demand during a downturn usually draws prices lower.
But it is a dreaded phenomenon for policymakers, as it leaves them hamstrung to act. If they raise interest rates, they risk further damage to an already weak economy and if they cut to help bolster the economy, the risk is further inflation.
What Are The Current Risks?
The economy is expected to slow in 2024. Purchasing manager surveys are already showing signs of slowing activity in manufacturing industries as inflation and higher interest rates cooled demand for consumer goods.
While inflation has eased in recent months - the December consumer price index report this week showed inflation rose again in the final month of 2023.
Analysts at Schroders are now considering whether the events unfolding in the Middle East could be inflationary as goods, no longer moving through the Red Sea and Suez Canal, are diverted around Africa - a much longer route that is adding to shipping costs.
In recent days this has pushed oil prices back up towards $80 a barrel and the main risk is that further escalation, now that U.S. forces have struck against the Houthis in Yemen, could push commodity prices even higher.
"In addition to trade frictions, a widening of tensions in the region could push oil prices up towards $120 per barrel," said David Rees, senior economist at Schroders.
In midday trading on Friday, oil prices had eased from their highs, but remained around 3% higher on the day, with Brent crude at $80 a barrel. The United States Oil Fund
Supply Chains
The chief risk for higher inflation would be if supply chains became blocked, as they did during the global Covid pandemic - which was the chief driver of the inflation currently being tackled by central banks.
The key difference here is that supplies are still getting through, but the costs of shipping are significantly greater with the Red Sea effectively closed.
John Kartsonas, managing partner at Breakwave Advisors, said: "Container rates have now doubled in the last two months. Tanker rates have had a more muted reaction, but it might be the case that they will react going forward given the escalating events."
Rob Thummel, managing director at Tortoise, added: "The current oil price does not reflect a geopolitical risk premium so prices could rise to over $80 per barrel should tensions in the Middle East continue to escalate."
Economic Downturn To Worsen?
So far, despite the evidence of slowing manufacturing growth, the U.S. economy, particularly the labor market, is holding up reasonably well with GDP growth of around 2.5% expected in 2023.
As long as the geopolitical situation doesn't worsen further, many analysts believe a soft landing - or even "no landing" - is possible for the U.S. economy in 2024.
Talking to Benzinga on Thursday, Bluford Putnam, former chief economist at CME Group, said: "We're going to post gross domestic product growth of 2.5%-3% for 2023. I wouldn't even call that a soft landing - I would say that is either average or slightly above potential GDP growth."
What Stocks For Stagflation?
For day traders, stagflation is one of the most difficult environments in which to trade. For longer-term investors, consumer staples and other non-cyclical stocks such as utilities are usually among the go-to sectors.
The Consumer Staples Select Sector SPDR Fund
While the Utilities Select Sector SPDR Fund
