Turmoil in the Middle East: Assessing the Longer-Term Implications

A new Citi Research report from a team led by Global Chief Economist Nathan Sheets assesses the uncertainties around the Middle East conflict, with a trim to expectations for 2026 global growth. But alongside this narrative about “heightened uncertainties” is another, more hopeful one to consider: “increased economic resilience.”

With challenges in the Middle East ongoing, the global economy faces amplified uncertainties. In the near term, the key question is how long the Strait of Hormuz will remain closed. Roughly 10 million barrels per day of oil are currently offline; should that disruption persist, it would represent a significant negative supply shock that would weigh on growth while pushing inflation higher.

At the same time, we think this narrative about “heightened uncertainties” needs to be balanced by a competing reality: “increased economic resilience.” In recent years, the global economy has absorbed a remarkable sequence of adverse shocks, yet growth has shaken off these shocks and continued at a solid, near trend pace. The production side of the global economy, in particular, is simply more adaptable and flexible than a decade or two ago, and so better able to navigate even severe challenges.

These dueling themes — uncertainty and resilience — were evident at the recent IMF World Bank meetings in Washington, where the tone was more pragmatic than a year ago, in the immediate aftermath of Liberation Day. That pragmatism has also been visible in markets, which we think reflects several underlying factors.

First, investment tied to artificial intelligence (AI) and other technological advances looks increasingly robust and transformative. While economic support is primarily coming through capital spending at the moment, we continue to believe that diffusion of the AI revolution through the economy will eventually raise productivity growth.

Second, there is growing familiarity with President Trump’s operating style and policy reaction function. The administration’s actions suggest it’s willing to tolerate increased market volatility while seeking to avoid a full scale recession.

Third, the resilience narrative itself has gained traction, with this message underscored by the global economy having absorbed last year’s tariffs with minimal challenges or disruptions. For investors, the lesson has increasingly been to look through shocks.

The global outlook

Given persistent geopolitical headwinds, we now expect global growth of 2.7% this year, down from 2.9% before the Middle East conflict. The largest markdowns are concentrated in parts of Asia, including Singapore, Vietnam, and the Philippines, with appreciable reductions also in Sweden and South Africa. India, by contrast, continues to look relatively resilient. At the same time, we’re raising our forecast for global headline inflation to 3.3% from 2.6%, largely reflecting higher energy prices.

Even so, we see our forecast as provisional. Like the markets, we are a notch more optimistic than we were a month ago. But downside risks remain material: In an adverse scenario where tensions flare again and Brent prices spike to $120 per barrel through year’s end, we estimate global growth could fall to a range of 1.5% to 2%, with headline inflation approaching 5%. In that environment, risks of recession or a disruptive stagflationary episode would rise sharply.

Market pricing implies major central banks — including the Fed, European Central Bank (ECB), Bank of England and the Reserve Bank of Australia — will run tighter monetary-policy paths in response to higher oil prices and inflation pressures, though these paths look less aggressive than they did a few weeks ago. Expectations for the Bank of Japan remain relatively unchanged, with a gradual normalization still anticipated. Reflecting this, we have raised our monetary-policy forecasts for 14 of the 27 major central banks we track. Notably, we now expect two ECB hikes this year, although we have some reservations about their advisability. In contrast, our U.S. team continues to believe the Fed will look through the oil shock and cut rates later this year.

Longer-term implications

Looking beyond the near term, this episode is likely to leave lasting marks on energy markets. Even in a favorable scenario where production comes back quickly, some Middle Eastern capacity has sustained damage, potentially leaving several million barrels per day offline for a year or longer. As a result, we expect a much tighter oil market during the year’s second half than we anticipated as the year began, with Brent closer to $75 to $80 per barrel rather than the pre conflict $60 path.

We also expect further diversification of energy supply chains. Asia, in particular, has been heavily dependent on flows through the Strait, and outright shortages have highlighted those vulnerabilities. Over time, we may see more oil from the Americas flowing to Asia and more Middle Eastern oil redirected toward Europe and the Americas. While this shift would be less efficient and result in somewhat higher oil prices, it would spread risk more evenly across consumers.

Finally, the episode is likely to accelerate efforts toward energy independence through domestic resource development, larger strategic inventories, efficiency gains, and increased interest in non petroleum energy.

A new global economic order?

More broadly, the Middle East episode intersects with a deeper reassessment of the global economic order. The Trump administration’s critique — that the U.S. bears disproportionate costs in the existing system — resonates with a wide swath of American voters, even if its specifics are debatable. In an increasingly multipolar world, there is a strong case for other countries to step up and shoulder increased responsibilities. That raises the question of what role the U.S. should take in this new world order, as well as what kind of reforms to the global architecture would address U.S. concerns.

In considering that question, the case has been made for updating global institutions such as NATO and the World Trade Organization. We think it’s time for global policymakers to have a broader conversation, with an eye on reforming, redefining and reimagining the current global system. Such changes could be complex and difficult, but also have the potential to bring important new opportunities.