Turmoil in the Middle East: Implications for Supply Chains

A new Citi Research report from a team led by Global Chief Economist Nathan Sheets looks at pressures on the world’s supply chains caused by the Middle East conflict. While the U.S.-Iran interim deal has eased some key headwinds for the global economy, it’s too early to say that risks and challenges are behind us. As we explore in our new Macro-to-Micro report, damage has been done to productive infrastructure in the Middle East and many challenges are likely to linger for global supply chains. 

We see the interim deal between the U.S. and Iran — as well as the reopening of the Strait of Hormuz — as an encouraging development for the global economy, but we think uncertainty around whether this agreement proves durable will continue to shape the macro outlook in the months ahead.

Oil markets have responded quickly to the deal, with Brent prices falling back to roughly $80 per barrel, their lowest level since the conflict began. Even so, the global economy has absorbed meaningful shock, as oil traded above $100 per barrel for sustained periods earlier this year.

Encouragingly, global activity has shown resilience. We currently expect global growth of about 2.5% this year, down from roughly 2.9% at the onset of the conflict. Meanwhile, global Purchasing Managers Indexes (PMIs) have held up well, with manufacturing posting its strongest readings in several years. Inflation, however, has been more visibly affected: We see global headline inflation running near 3.5% this year, about a full percentage point higher than before the conflict.

Looking ahead, the trajectory of oil prices — and, by extension, the durability of the Strait’s reopening — remains central to our outlook. If the agreement holds and shipping flows normalize, we expect Brent to average roughly $75 per barrel in the second half of the year. That level still sits meaningfully above our pre-conflict baseline, reflecting damage to capacity and increased demand to restock inventories, though that could be partially offset by the potential for increased Iranian exports. Under this scenario, we would expect global growth to land broadly in line with our current forecasts.

Alternatively, a renewed disruption would materially worsen the outlook. If oil prices were to climb toward $120 per barrel through the year’s second half, we estimate global growth would fall well below 2%, while headline inflation would approach 5%. This wouldn’t necessarily constitute full stagflation, but it would bring clear headwinds for consumers, labor markets and central banks, and intensify pressures on fiscal performance worldwide.

One important offset in the current cycle has been the strength of AI-related investment. In the U.S., such investment surged to well over $400 billion (annualized) in the first quarter and could exceed $600 billion for the full year. This strength is also spilling over into other economies, supporting growth in South Korea, Taiwan, Japan and China.

At the same time, supply-chain pressures have re-emerged as a meaningful risk. Our Global Supply Chain Pressure Index rose sharply through March and April, flattening somewhat in May but remaining nearly one standard deviation above its pre-pandemic average. Outside of the pandemic period, these are the highest levels we have seen since the disruptions of 2021–2022.

To date, the pressure has been driven primarily by higher shipping costs and rising input prices reflected in PMIs. Energy costs — including diesel and jet fuel — have played a central role. While container shipping costs have increased, they have not approached the peaks seen during the Red Sea disruptions in 2024, partly due to expanded global shipping capacity. Encouragingly, inventory pressures and order backlogs remain relatively contained, though some firms appear to have preemptively built buffers.

Even if the Strait remains open, we expect some of these supply-chain frictions to linger. Shipping flows are unlikely to normalize immediately, damaged production capacity will need to be restored, and it will take time to untangle the supply-chain tensions that have already emerged — following the pandemic, we note, the normalization process took about 18 months. While this episode appears less severe than the pandemic shock, some sectors could experience residual pressures into 2027.

From a macro perspective, we continue to rely on “rules of thumb” to gauge the impact of oil shocks. Broadly speaking, a 10% increase in oil prices tends to reduce global growth by roughly 15 to 20 basis points while raising headline inflation by about 30 to 40 basis points (and core inflation somewhat less). These effects are smaller than in past decades, reflecting lower energy intensity and greater economic flexibility.

However, we see risks that supply-chain disruptions amplify these effects. In particular, second-round price pressures — such as higher transport costs feeding into goods prices or rising airfares — could push core inflation higher than these estimates would suggest. Historically, we have also observed a relatively tight relationship between supply-chain stress and core inflation, suggesting that sustained disruptions could have a more pronounced impact.

We are also mindful that these dynamics may be nonlinear. Early in a shock, firms may absorb higher costs through margins or inventories. But as pressures intensify, they may reconfigure supply chains, reduce output, or pass costs through more aggressively, leading to stepped-up macro effects.

At a sector level, the impacts are uneven:

• Helium and semiconductors appear relatively resilient, supported by prior oversupply, long-term contracts, and recycling capabilities.
• Petrochemicals face more persistent strain, with meaningful portions of global capacity offline or hampered and a slow path to normalization.
• Fertilizers have seen sharp price increases, raising concerns about agricultural costs and potential downstream food-price pressures.
• Aluminum disruptions look likely to linger, as restarting damaged capacity may take considerable time.
• Airlines remain sensitive to fuel costs, with limited ability to fully pass through large shocks, leading to differentiation across business models.
• North American transportation and logistics have shown resilience, largely due to fuel cost pass-through, though downstream industries are absorbing the pressure.