Iran war could lead to U.S. inflation shock, says Allianz’s Mohamed El-Erian

Summary

• El-Erian warns the economy is moving from a price shock to combined price and demand shocks due to the war, triggered by multiple tipping points.
• He is more concerned than average because the war is asymmetrical, with three to four parties believing they're winning, making it hard to end.
• Demand destruction is accumulating globally, with Asia worried about physical shortages, not just high oil prices, which could be another tipping point.
• He has shifted from reduced risk to maximum risk and now finds only a few individual stocks attractive, but would not buy the broad market index at this juncture.
• In absolute terms, the U.S. faces an energy price shock leading to an inflation shock, likely reducing spending, especially for lower-income households.
• If the war continues, the sequence could escalate to financial instability, starting from energy shock to inflation shock to demand shock.
• Key tipping points include disruption turning to damage (e.g., Qatar's LNG exports disrupted for 3-5 years) and attacks on infrastructure affecting commodities like aluminum, fertilizers, and helium.
• Markets are underpricing the disruption: physical oil prices in Asia are 140-150, but futures are lower; equities still view the shock as transitory.
• Policy flexibility is limited, with reduced ability for Fed or fiscal measures to bail out the economy as in the past.
• The outlier scenario of $200 per barrel oil is moving closer as the war prolongs, increasing risks of infrastructure damage and longer-term shocks.