CICC: The impact of oil shocks on the United States may be greater than on China

Abstract

The Middle East conflict is a typical supply shock, with its direct impact being the disruption of crude oil supply and rising oil prices. For the United States, which is already facing supply shortages, slow inflation decline, and rising government debt, the escalation of the Middle East conflict exacerbates its "stagflation" risk, leaving macroeconomic policy in a dilemma. We believe that if the conflict does not last long, its impact may be relatively mild. However, if the conflict continues to escalate, the fundamental pressures and financial risks in the U.S. may increase, potentially amplifying the spillover effects on the global economy and markets.

In contrast to the relative supply shortage in the U.S., China is currently in a macroeconomic state of relatively weak demand, which may result in the overall negative impact of the crude oil supply shock triggered by the Middle East conflict being less severe for the Chinese economy than for the U.S. We believe that under mild scenarios, although the overseas "stagflation" risk puts pressure on the overall export volume, China's export share may receive some support due to its lower dependence on overseas energy and the drive of the new energy transition. Comprehensive estimates suggest that under mild scenarios, the actual GDP growth rate for the year may be around 4.8% (5% in 2025), while the nominal GDP growth rate may rise to around 5.3% due to inflation (4% in 2025). At the industry level, profits will show differentiation, with mid- and downstream industries potentially facing profit pressure due to limited price transmission capability. If the conflict continues to escalate, leading to greater risk scenarios, it will be necessary to further strengthen macroeconomic policy measures to achieve growth targets.

Main Text

The direct impact of the Middle East conflict on the economy mainly transmits through the reduction of crude oil supply. Recently, the shipping in the Strait of Hormuz, an important global oil transportation route, has been severely obstructed, leading to tight oil supply and pushing oil prices higher. Additionally, damage to oil production facilities in the Middle East has also impacted crude oil supply. Looking ahead, the key variable affecting the magnitude and duration of international oil price increases is the duration of the blockade of the Strait of Hormuz. Given the current uncertainty in the Middle East situation, assessing the impact of the conflict on the macroeconomy requires different scenario assumptions. Since the military strikes by the U.S. and Israel against Iran at the end of February [1], under mild scenarios, if the Strait of Hormuz returns to normal within one month, according to the judgment of the CICC Commodity Group, the Brent crude oil price centers for Q1 to Q4 this year may be around $75, $80, $75, and $72.5 per barrel; under risk scenarios, if the blockade of the Strait of Hormuz lasts for about three months, the price centers for the four quarters may be around $80, $120, $90, and $80 per barrel. In a greater risk scenario, if the blockade lasts for six months or more, the price centers for the four quarters may be around $85, $150, $110, and $90 per barrel. Based on these different scenario assumptions, we analyze the macroeconomic trends in the U.S. and China accordingly.

United States: Beware of the Interplay of Stagflation and Financial Risks

The U.S. is already facing challenges of supply shortages, and the supply shock brought about by the Middle East conflict will undoubtedly elevate its "stagflation" risk. Rising oil prices may push up inflation in the U.S. The increase in oil prices not only directly raises the energy component prices in the CPI but also transmits through transportation, manufacturing, and other links to a broader range of goods and services prices Historical experience shows that a 10% increase in oil prices typically drives the U.S. CPI to rise by about 0.25 percentage points year-on-year. In a moderate scenario, we estimate that the U.S. CPI year-on-year will be 3.1% in 2026; in a risk scenario, the U.S. CPI year-on-year may rise to 3.8%; and in the aforementioned larger risk scenario, the U.S. CPI year-on-year may further rise to 4.4%, with inflation expectations potentially being pushed higher again, exacerbating the complexity and stickiness of inflation.

In both moderate and risk scenarios, since the U.S. is an oil-producing country, its economy has a slightly stronger ability to withstand rising input oil prices compared to other non-oil-producing countries, but it will still be impacted by diminished purchasing power and rising costs. The increase in oil prices will not only drive up inflation and suppress consumer demand but will also exert pressure on the manufacturing sector from the cost side. However, since the rapid development of the U.S. shale oil industry since 2010 has given the U.S. a certain capacity for oil exports, rising oil prices are expected to boost profits and investments in the oil and gas industry, partially offsetting economic downward pressure. According to literature estimates, a 10% increase in oil prices has a negative impact of about 0.05 percentage points on U.S. GDP in the first year, so we estimate that in a moderate scenario, the U.S. real GDP year-on-year will be 1.6% in 2026, while in a risk scenario, the U.S. real GDP year-on-year may decline to 1.5%.

It is worth noting that considering the current vulnerabilities in the U.S. financial sector are gradually becoming apparent, high oil prices in a larger risk scenario may trigger broader financial shocks, leading to nonlinear economic impacts. Currently, the overall liquidity in the U.S. financial system is relatively tight, and under the intertwining of marginal economic slowdown and geopolitical uncertainties, market sentiment is relatively weak. If energy prices continue to soar, exacerbating concerns about "stagflation," it may lead to a rapid decline in risk appetite and a significant tightening of financial conditions. Especially in the private credit market, which has lower asset transparency, the dual pressure of "high interest rates + high costs" may accelerate the exposure of default risks for highly leveraged, weak-quality, and lightly collateralized enterprises. According to literature estimates, a 100 basis point increase in credit spreads would lead to a slowdown in real GDP growth of more than 1.25 percentage points over the subsequent four quarters. This also means that if a "supply-side shock + passive tightening of financial conditions" resonance occurs, it may pose a more severe, even nonlinear, downside risk to the fundamentals of the U.S. economy, with the possibility of GDP slipping into negative growth territory not being ruled out. In short, against the backdrop of insufficient supply and inflation being inherently difficult to manage, we believe that the high oil prices resulting from supply shocks are a heavy burden that the U.S. economy cannot bear.

In summary, the U.S. is currently facing rising oil prices and deep-seated inflation pressures, coupled with a slowing job market, putting the Federal Reserve in a policy dilemma. On one hand, the risks of job downturn are prominent, and high interest rates continue to suppress residents' purchasing power and interest-sensitive sectors like real estate, all of which require a marginal shift towards easing monetary policy to prevent further weakening of economic momentum; on the other hand, the stickiness of inflation combined with rising energy prices constrains the space for interest rate cuts, making it difficult for policy to shift quickly. We expect that in the short term, the Federal Reserve will continue to weigh between stabilizing employment and controlling inflation, likely maintaining a wait-and-see approach, with the resumption of interest rate cuts possibly delayed until the second half of the year

China: Under Mild Conditions, the Impact of the Medium is Greater than the Macro

China and the United States are in different macro supply and demand states, with the U.S. experiencing supply shortages and China facing weak demand. Therefore, we judge that the impact of supply shocks on China will overall be less than that on the U.S., and we focus more on the differentiation at the medium level.

Regarding PPI, the rise in oil prices will directly push up prices in the upstream industries of oil and gas extraction and the petroleum, coal, and other fuel processing industries. In addition, the increase in oil prices will also have indirect effects on other components of PPI, such as affecting the prices of downstream products in the crude oil industry chain (like chemical raw materials, chemical fibers, chemical products, pesticides, and fertilizers) through cost impacts, as well as the prices of products in industries that rely on oil and gas as energy sources, such as gas production and supply, transportation, and certain mining industries. Our empirical model shows that for every 10% increase in oil prices, PPI will rise by about 0.3-0.4 percentage points year-on-year. However, under our country's refined oil pricing mechanism, past experience indicates that when international oil prices exceed $80 per barrel, the adjustment range of domestic refined oil prices will decrease; when it exceeds $130 per barrel, the impact may no longer increase. We expect that under mild conditions, this year's PPI may show a trend of rising first and then falling year-on-year, turning positive and reaching a peak in the second quarter, and then declining in the second half of the year as oil prices fall, with the average year-on-year PPI for the four quarters being -1.0%, 1.0%, 0.4%, and -0.4%, respectively, resulting in an annual average of around 0%. In risk scenarios and greater risk scenarios, the annual year-on-year PPI may rise to about 1.1% and 1.6%, respectively.

The rise in international oil prices also has a second-round effect on CPI. The first-round effect is that international crude oil prices are directly transmitted to domestic refined oil prices, reflected in the rise of CPI for fuel used in transportation and utilities for housing; the second-round effect is through increasing energy costs in production activities, which then transmits to the prices of food and other non-food CPI. We expect that under mild conditions, this year's CPI year-on-year for the four quarters may be 0.8%, 1.0%, 0.6%, and 0.4%, respectively, resulting in an annual average of around 0.7%; in risk scenarios and greater risk scenarios, the annual year-on-year CPI may be around 1.1% and 1.5%, respectively. Correspondingly, we expect that under mild conditions, this year's GDP deflator inflation will be around 0.5%; while in risk scenarios and greater risk scenarios, the GDP deflator inflation for the year may be around 1.1% and 1.5%, respectively.

Under mild conditions, the total export volume is limited in impact, while there are two major positive structural factors. In terms of total volume, the overseas "stagflation" risk brings uncertainty to China's exports. Research by the IMF shows that a 10% rise in energy prices sustained for a year will increase the global inflation rate by 40 basis points and slow economic growth by 0.1%-0.2%, which may affect our exports. Structurally, China's export share may be supported. Since China's dependence on overseas energy is far lower than that of major competitors such as Europe, Japan, and South Korea, the negative impact on China's industrial production from crude oil supply shocks may also be lower than that on other major export-oriented economies, thereby increasing China's export share Especially for related high-energy-consuming industries, this effect may be more pronounced. A comparable situation is seen after the Russia-Ukraine conflict, where the production of high-energy-consuming industries in the Eurozone was restricted, leading to a decline in export share, while China, leveraging its relative supply chain advantages, further increased its actual export share. On the structural side, a second positive factor is that rising oil prices may accelerate the global transition to new energy, thereby boosting China's exports of new energy, electrical equipment, and other related products. A similar phenomenon was observed after the Russia-Ukraine conflict in 2022. Overall, we expect that under mild, risk, and greater risk scenarios, the negative impact on annual exports will be 0.6, 1.6, and 2.6 percentage points, with year-on-year growth rates of 7.0%, 6.0%, and 5.0%, respectively.

From the perspective of enterprises, aside from the directly benefiting related upstream industries, for many downstream industries, the oil supply shock may suppress corporate profit expectations, thereby partially dampening corporate investment willingness. On the other hand, it will also increase the raw material and financing costs of corporate investments, thus reducing the actual scale of corporate investments. From the government's perspective, if the growth rate of corporate investments declines due to the oil supply shock, the government may further increase infrastructure investment to stabilize overall investment. Of course, when both factors are combined, we believe that the overall investment will be suppressed under the oil supply shock. Overall, we expect that under mild, risk, and greater risk scenarios, the negative impact on annual fixed asset investment will be 0.9, 1.2, and 1.5 percentage points, with year-on-year growth rates of -0.4%, -0.7%, and -1.0%, respectively.

The transmission chain of oil prices to consumption is relatively long, and the supply shock's impact on CPI is less than that on PPI, mainly affecting consumption indirectly through channels such as suppressing economic activity and reducing residents' actual disposable income. Specific categories of consumer goods, such as refined oil and water and electricity fuels, are significantly affected by oil prices and are relatively rigid in household consumption expenditure, which may lead to passive increases in nominal consumption expenditure due to price impacts. We expect that under mild, risk, and greater risk scenarios, the growth rates of total retail sales will be 3.0%, 2.8%, and 2.5%, respectively.

Overall, we expect that under mild, risk, and greater risk scenarios, the negative impact on annual GDP growth rates will be 0.2, 0.5, and 0.8 percentage points, respectively. Under the mild scenario, the actual GDP growth rate in 2026 may be around 4.8%. Under risk and greater risk scenarios, policy countermeasures may be intensified to achieve growth targets. Compared to the forecasts in the annual outlook, under the mild scenario, net exports may contribute an increase of 0.1 percentage points, while consumption and capital formation may decrease by 0.15 percentage points each; under the risk scenario, net exports may remain flat, while consumption and capital formation may decrease by 0.25 percentage points each; under the greater risk scenario, net exports, consumption, and capital formation may decrease by 0.1, 0.35, and 0.35 percentage points, respectively.

The impact of the oil supply shock on industry profits varies. From an industry impact perspective, the rise in oil and gas prices, as a cost shock, may drive price increases in related industries. However, when demand is relatively weak or industry pricing power is low, the price transmission capability of downstream industries is limited, or the extent of price increases will be limited, leading to a reduction in their profits From historical experience, industries that have a positive correlation between year-on-year oil and gas prices and industry profits include oil and gas extraction, coal mining, black metal mining, non-metallic minerals, non-ferrous metal smelting, and chemical raw materials manufacturing, indicating that they may benefit when oil prices rise; while industries that have a negative correlation include fuel processing, electric heat production and supply, electrical machinery, and metal products, indicating that their gross profits may be adversely affected when oil prices rise.

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