Citadel warns: War impact has entered the "second phase," with energy shocks just the beginning; downside growth risk is even greater.

Market interpretation of the Middle East conflict is shifting. As the conflict continues, the market’s focus has moved from hawkish repricing of inflation and monetary policy to a deeper logic of growth destruction.

In its latest report, Citadel Securities warned that global supply chains have sustained structural damage that cannot be quickly repaired, and the current market’s assessment of how severe physical shortages are remains systematically underestimated.

The firm’s analyst, Frank Flight, noted that the conflict’s first phase has largely played out according to the script of a hawkish policy shock—surging energy prices drive a repricing of inflation expectations, and central banks in turn issue tightening signals. However, the policy framework referenced against 2022 is likely a misreading in the current environment. Unlike in 2022, the global economy today lacks the buffering conditions of large-scale fiscal stimulus, a highly tight labor market, and excess savings, making it overall more fragile.

Concerns about the growth outlook are starting to wrestle with inflation pressures. Citadel Securities believes that once global short-end interest rates stabilize, forward real rates will become the core of the market’s trading narrative for growth.

Far more than an energy shock: physical shortages are quietly spreading

In the report, Citadel Securities emphasized that the current market pricing of supply-chain shocks still relies mainly on crude oil futures, and futures prices are materially underestimating the severity of physical shortages. Taking Oman crude as an example, its spot price has reached $160 per barrel, which is at a clear premium versus futures prices, reflecting acute shortages in Asian markets and elevated physical premiums.

The firm stressed that this shock should not be viewed as a simple energy-price shock, but rather a broad-based supply shock that has both price effects and quantity effects. As previously in-transit cargoes arrive at their destinations and inventories continue to be consumed, the market will increasingly face a situation of shrinking physical available quantities rather than buffering via inventories. At that point, the price discovery mechanism may decisively shift toward marginal unit pricing of scarce supply.

In addition, the scope of shortages goes far beyond crude oil itself, encompassing refined products, liquefied natural gas, helium, fertilizers, and other key industrial inputs. Citadel Securities specifically flagged that a physical helium shortage could pose a substantial constraint on semiconductor manufacturing, which would then spill over into data-center construction. And because AI infrastructure has similarly high energy intensity, it would be difficult to remain immune to the butterfly effects of the global supply chain.

Same road, different paths: both scenarios point to demand contraction and growth downgrades

Citadel Securities lays out two scenarios, but believes that both will ultimately lead to demand contraction and downward revisions of growth outlooks.

In the first scenario, the supply shock itself would directly erode demand in an environment lacking excess demand support; in the second, if growth proves more resilient, central banks will proactively tighten to offset inflation pressures.

The firm noted that the transmission mechanism of tightening financial conditions is crucial—if driven by policy, the process is typically painful but controllable because central banks retain the ability to reverse course; but if market-driven, deteriorating growth expectations will widen credit spreads, compress stock valuations, and lift the dollar, creating a self-reinforcing tightening cycle.

This dynamic is especially pronounced in emerging markets, particularly energy-importing countries. Deteriorating terms of trade will weigh on the local currency, forcing central banks to tighten passively to defend the exchange rate. The resulting weakness in emerging-market assets will then feedback into global growth and amplify the tightening effects worldwide.

Call option value for the dollar stands out; AI capital expenditure in doubt

On the FX strategy front, Citadel Securities believes that given the dollar’s relatively moderate rise so far, and that implied FX volatility remains low across assets, call options on the dollar offer attractive, asymmetric protection against a scenario of renewed conflict escalation.

The firm also warns about the sustainability of AI capital expenditures. The report states that if global financial conditions tighten disorderly while growth expectations and risk appetite decline simultaneously, whether AI capex can sustain its current growth rate is uncertain. This risk has eased if the conflict’s near-term escalation is less intense; however, given the more fragile fundamentals of the global economy after this shock, the risk cannot be ruled out.

Citadel Securities concludes that the next phase of market direction will depend more on the magnitude of the growth shock than on the escalation dynamic itself. The level and timing of tightening financial conditions will be key indicators for assessing spillover effects.

Risk disclosure and disclaimer

        The market involves risk; investment should be cautious. This article does not constitute personal investment advice, nor does it consider individual users’ specific investment objectives, financial situations, or needs. Users should evaluate whether any opinions, viewpoints, or conclusions herein are suitable for their particular circumstances. Investment involves risk, and you bear the responsibility.