Red Sea Disruptions Could Dampen the European Economy
The recent attacks in the Red Sea have led to shipping disruptions and increased costs; on routes between Asia and Europe the costs have more than doubled.1 According to research by the International Monetary Fund, when global freight rates double, inflation tends to pick up by 70 basis points (bps) in the subsequent 12 to 18 months.2 Furthermore, prolonged disruption in the Red Sea may force some European companies to downsize or halt production altogether.3 Many investors are considering if and how this all could affect the European Central Bank's (ECB's) policy-rate trajectory.
We examined two possible downside-risk scenarios related to surging freight costs:
- Delayed rate cuts: Higher freight costs push up inflation and ECB rate cuts are not expected before the third quarter of this year. The impact on the economy and risk assets is muted.
- Minor economic damage: Surging freight costs contribute to higher inflation but also cause some damage to the European economy. The ECB rate cuts come later than current market expectations, but sooner than in the first scenario because of the economic slowdown.
Impact to portfolio values under our scenarios
Portfolio impact of the scenarios based on market data as of Feb. 5, 2024. Portfolio results are relative to EUR base currency. EUR sovereigns, equities and corporate bonds are represented by MSCI indexes. The composite portfolio is 60% European public equities, 20% EUR sovereigns, 10% EUR investment-grade bonds and 10% EUR high-yield bonds.
Our scenario assumptions
These scenarios are not forecasts, but hypothetical narratives of how surging freight costs could affect multi-asset-class portfolios. MSCI clients can access BarraOne® and RiskMetrics® RiskManager files for these scenarios on the client-support site.
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1 Based on “Red Sea Shipping Disruption News & Updates,” by Freightos, Feb. 1, 2024.2 Yan Carrière-Swallow et al., “How Soaring Shipping Costs Raise Prices Around the World,” International Monetary Fund, March 28, 2022.3 Robert Wright, Laura Onita and Peter Campbell, “European manufacturers and retailers face ‘chaotic’ period after Red Sea attacks,” Financial Times, Jan. 21, 2024.
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