Geopolitical tensions could spark inflation beyond oil prices, warns Jefferies

Escalating geopolitical tensions in the Middle East could trigger a fresh wave of global inflation that extends well beyond higher crude oil prices, according to a new report by Jefferies, which argues that disruptions to shipping routes and supply chains may prove more damaging to the global economy than markets currently anticipate.

In its latest GREED & fear report titled "World War III and capex aversion", Christopher Wood, Global Head of Equity Strategy at Jefferies, said investors may be underestimating the inflationary risks arising from prolonged geopolitical uncertainty, even as artificial intelligence (AI) continues to hold long-term deflationary potential.

The brokerage noted that while advances in AI could eventually lower production costs and improve productivity, any significant escalation in geopolitical conflict would likely have the opposite effect in the near term.

"The outbreak of World War III would be inflationary in the first instance," the report said, adding that continued disruptions to Gulf shipping lanes would push up costs across a broad range of sectors rather than just energy markets.

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Shipping disruptions could broaden inflation

According to Jefferies, the market has largely focused on crude oil prices as the primary gauge of geopolitical risk. However, the report argues that inflationary pressures are more likely to emerge through higher costs for liquefied natural gas (LNG), refined petroleum products, freight, marine insurance and wider supply chains if shipping routes remain partially or fully disrupted.

The report added that these pressures would be more apparent to businesses involved in manufacturing, logistics and trade than to financial market participants focused primarily on asset prices.

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Bond market reflects growing concerns

Jefferies also pointed to recent movements in the US Treasury market as evidence that investors are becoming increasingly concerned about geopolitical developments.

The report highlighted that the 30-year US Treasury yield climbed to 5.22%, its highest level since July 2007, while the 10-year Treasury yield rose from 4.61% to 4.68% over a short period. The increase coincided with uncertainty following the latest Federal Reserve meeting and heightened geopolitical tensions.

While the brokerage acknowledged that long-term inflation expectations remain relatively contained, it argued that current geopolitical developments resemble periods preceding major historical conflicts, increasing the risk of persistent inflationary pressures.

Markets questioning AI spending

Beyond geopolitics, the report said investors have started reassessing the enormous capital expenditure plans announced by major technology companies for artificial intelligence infrastructure.

Jefferies noted that semiconductor stocks have corrected sharply and warned that markets are beginning to react negatively to rising AI-related capital expenditure, particularly when it weighs on free cash flow. Alphabet and Meta faced investor pressure after reporting weaker free cash flow alongside elevated AI spending, while Microsoft outperformed after maintaining its capital expenditure guidance.

The brokerage said it remains too early to conclude that hyperscaler AI investment is slowing, as earnings estimates for major memory-chip companies have not yet been revised lower. However, it described the market's changing reaction to higher capital expenditure as an important signal for investors to monitor in the coming months.

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