Citadel warns: War impact has entered the "second phase," with energy shocks just the beginning; downside growth risk is even greater.

Ask AI · How does the Middle East conflict trigger deep concerns in the market about growth prospects?

The market’s interpretation of the Middle East conflict is changing. As the conflict continues, the focus has shifted from hawkish repricing of inflation and monetary policy to a deeper logic of growth destruction.

In its latest report, Citadel Securities warned that global supply chains have suffered structural damage that cannot be quickly repaired, and the market’s systemic underestimation of the severity of physical shortages remains.

Analyst Frank Flight noted that the first phase of the conflict has basically followed the script of a hawkish policy shock—energy prices surge, driving a revaluation of inflation expectations, and central banks subsequently emit tightening signals. However, using 2022 as the reference framework is likely a misinterpretation in the current environment. Unlike 2022, today’s global economy lacks key buffers such as large-scale fiscal stimulus, a highly strained labor market, and excess savings, making it overall more fragile.

Concerns about the growth outlook have begun to trade off against inflation pressures. Citadel Securities believes that once global short-term interest rates stabilize, forward real rates will become the core of the market’s growth narrative.

Far more than an energy shock: physical shortages are quietly spreading

The report emphasizes that the current market’s pricing of supply chain shocks still mainly relies on crude oil futures, yet futures prices are substantially underestimating the severity of physical shortages. For example, Oman crude’s spot price has already reached $160 per barrel, with a clear premium over futures prices, reflecting acute shortages in Asian markets and high physical premiums.

The firm stresses that this shock should not be viewed simply as an energy price shock, but as a broad supply shock with both price effects and quantity effects. As previously in-transit cargoes arrive at destinations and inventories continue to be depleted, the market will increasingly face a situation where physical availability shrinks rather than just inventory buffers. At that point, price discovery may decisively shift to marginal unit pricing of scarce supply.

Moreover, the scope of shortages extends far beyond crude oil itself, including refined products, LNG, helium, fertilizers, and other key industrial inputs. Citadel Securities specifically warns that helium shortages could pose substantial obstacles to chip manufacturing, which would then impact data center construction— and the high energy intensity of AI infrastructure makes it equally vulnerable to the butterfly effects of global supply chain disruptions.

Same path, different routes: both scenarios point to demand contraction and growth downgrades

Citadel Securities outlines two scenarios but believes that both will ultimately lead to demand contraction and downward revisions of growth outlooks.

In the first scenario, the supply shock itself will directly erode demand in an environment lacking excess demand support; in the second, if growth proves more resilient, central banks will actively tighten to offset inflationary pressures.

The firm highlights that the transmission mechanism of tighter financial conditions is crucial—if driven by policy, tightening is usually painful but controllable because central banks can reverse course; but if driven by market expectations, worsening growth outlooks will widen credit spreads, compress stock valuations, and strengthen the dollar, creating a self-reinforcing tightening cycle.

This dynamic is especially prominent in emerging markets, particularly energy-importing countries. Deteriorating terms of trade will suppress local currencies, forcing central banks to tighten passively to defend their currencies. The resulting weakness in emerging-market assets then feeds back into global growth and amplifies the tightening effect worldwide.

Bullish dollar options are increasingly valuable, but AI capital expenditure remains uncertain

In FX strategies, Citadel Securities believes that, given the relatively modest rise of the dollar so far and the still-low implied volatility across assets, bullish dollar options offer attractive asymmetric protection against scenarios where the conflict escalates again.

The firm also warns about the sustainability of AI capital expenditures. The report states that if global financial conditions tighten disorderly while growth expectations and risk appetite decline simultaneously, whether AI capex can sustain its current growth rate remains uncertain. This risk is somewhat mitigated if the conflict short-term escalates, but given the more fragile global economic fundamentals after this shock, the associated risks cannot be ruled out.

Citadel Securities concludes that the next phase of the market will depend more on the magnitude of the growth shock than on the escalation dynamics themselves. The level and pace of financial tightening will be key indicators for assessing spillover effects.