Turmoil in the Middle East: Headwinds for the Global Economy

A new Citi Research report from a team of economists led by Nathan Sheets considers the recent turmoil in the Middle East and concludes that it’s dramatically shifted the balance of risks for the global economy to the downside. 

For now, we have only modestly downgraded our 2026 global growth forecast to 2.7%, down 0.2 percentage point from February. However, we are broadly in “wait and see” mode, given the rapid evolution of the conflict and the wide range of potential outcomes.

If oil prices spike only briefly, our existing forecast — or something close to it — could still hold. But more severe scenarios are also in play. In particular, if the Strait of Hormuz remains closed for a sustained period, Brent oil prices could plausibly stay above $100 a barrel through much of the year. This could push global growth to below 2%, bringing amplified recession risks, particularly for oil importing economies. And global headline inflation could jump to well above 4%.

More generally, we estimate that every 10% increase in oil prices reduces global growth by around 15 to 20 basis points (bps), while raising headline inflation by 30 to 40 bps and core inflation by some 10 bps. But we also note that these sensitivities are smaller than in past decades, reflecting a global economy that has become more flexible and resilient.

Given a bewildering range of possibilities, we offer three observations for helpful framing and context.

First, higher oil prices are not the only transmission channel. Energy dependent supply chains — including fertilizers, aluminum, plastics and other petrochemicals, and helium used in semiconductor manufacturing — are also vulnerable. In addition, heightened uncertainty is weighing on households, firms and markets. The upshot is likely to be reduced consumption and investment, increased market volatility, and weaker economic performance.

Second, oil prices remaining above $100 per barrel for most of the year would cause the risk of a full-blown global recession to rise appreciably. But it wouldn’t automatically become our baseline, as the world economy has weathered a series of major shocks in recent years while maintaining near trend growth. Compared with the 1970s, energy intensity (the amount of energy required to generate a unit of gross domestic product) has fallen by roughly half, the global economy is less exposed to developments in oil markets, and governments have accumulated massive energy reserves to help buffer supply disruptions.

Third, we see current oil futures as reflecting a probability weighted average of two scenarios: a more benign case in which pressures in the Strait ease over the next few months, and the severe case noted above. Market pricing swung toward the more severe outcomes, but the announcement of a brief cessation of hostilities to allow for negotiations has led to some moderation. As Fed Chair Powell recently noted, “It’s just that we don’t know what the effects [of the turmoil] will be. And, really, no one does.”

In addition to the broader picture, we think it’s important to consider the country level implications, asking where the pain is likely to be most acute and which economies may be better positioned.

Although oil shocks redistribute income from importers to exporters, they still create global headwinds because oil importing economies generally have higher marginal propensities to spend. Higher oil prices quickly squeeze consumers’ real incomes, while the income gains for exporters are often slower to emerge and less pronounced. Capital obsolescence and other costly adjustments add further drag, particularly for the corporate sector.

Upon looking more closely, Asia stands out as the most vulnerable region. South Korea, Japan, and India are heavily dependent on imported fuel and directly exposed to flows through the Strait of Hormuz; their financial markets have already come under pressure. China also faces significant exposure, but its vast strategic oil reserves and likely increased imports from Russia should help cushion the blow.

Europe is also facing meaningful headwinds. EU economies are oil importers and thus suffer a negative term of trade shock as prices rise. In addition, disruptions to Qatari natural gas supplies are compounding pressures, though the gas shock is smaller than in 2022.

The U.S. and Canada, as net oil exporters with limited direct exposure to the Strait, are comparatively better positioned, though higher oil prices will still generate headwinds. This relative resilience is evident in the widening spread between Brent and WTI prices.

Middle Eastern oil exporters, which would normally benefit from higher prices, are instead on the negative side in this episode, as significant portions of their supply are shut in and infrastructure remains vulnerable. Russia, by contrast, may emerge as a significant winner given elevated prices and the temporary relaxation of U.S. oil sanctions. Other exporters outside the Middle East — such as Norway, Kazakhstan, Nigeria and Angola — also appear relatively well positioned.