The sharp drop in oil prices is both a blessing (especially for consumers and inflation indices) and a threat (for Saudi Arabia and Russia notably, amongst others). Similarly, the newfound European unity around a common defence programme involves a delicate balancing act – between opportunities for more efficient EU governance on the one hand, and the risks of escalating indebtedness/slower future economic growth on the other. As for investors, they too face a difficult choice: how to preserve their capital in this highly uncertain economic and geopolitical context, while also taking advantage of market opportunities brought about by increased volatility?
Year-to-date, oil prices have dropped by 15%, due to the combination of weaker demand expectations and higher supply. The demand side of the equation pertains of course to slowing economic growth across the globe and fears of a recession in the US. On the supply front, US shale production is back to record levels and, within the OPEC+ complex, the main quota overruns appear to be attributable to Iraq and Kazakhstan. Saudi Arabia’s current acceptance of lower oil prices might thus reflect a desire to instil discipline in these countries. At the risk, however, of jeopardising its own public finances, since current oil prices are well below the USD 80 level that Saudi Arabia needs to achieve a balanced budget. Russia is also likely to view low oil prices with dismay. After all, it is its main source of revenue – providing funding for the war against Ukraine.
Beyond the Saudi budget, a prolonged period of low oil prices could destabilise future production plans – setting the stage for a medium-term supply shortage. For US shale producers, we estimate the “pain level” to be around USD 50. For new offshore drilling projects, ever further out at sea and thus more costly, it is probably closer to USD 60. Overall, we note that capital spending plans of mid- to large-sized oil and gas companies, after several years of recovery from their 2020 lows, are looking flattish for 2025, with a clear risk of cuts being made during the coming quarters.
From a US consumer perspective, lower oil prices offer some respite insofar as they help offset the inflationary effects of President Trump’s tariff policies. The fact that the US dollar seems to be stabilising (with odds of an imminent eviction of the US Federal Reserve Chair by President Trump having now subsided) is also supportive of the immediate US inflation outlook. That said, Mr. Powell’s term at the helm of the Federal Reserve ends in May 2026. Concerns regarding the independence of the US central bank after Powell are thus likely to resurface again in a not-so-distant future.
In our view, what the Trump administration has embarked upon seems no less than a true “revolution”. It is clearly trying to destroy the current system (a liberal, capitalist and democratic rule of law, embedded in an international world order) but appears not to know exactly what to replace it with, nor how to get there. And so far, little opposition has been encountered, be it by the US population, political parties or foreign countries. Congress has effectively been circumvented by the use of the National Security Act, which grants the president certain (exceptional) decretal powers. The only headwinds at this point are coming from court rulings, which we see as a key factor in slowing the pace of “systemic change” going forward. Can President Trump really continue to go against the courts? How will he respond to Democrat state governors enforcing court rulings rather than presidential executive orders? And what of the judicial actions being taken by powerful institutions such as Harvard university? For now at least, the overall picture remains very unclear and unpredictable.
Turning to Europe, the first round of the (re-run) Romanian presidential election saw the far-right candidate come out in the lead. If his victory is confirmed on 18 May, Romania will be another EU country to come under the influence of nationalist, right-wing populist (pro-Russian) parties. Together with a “silent” far-rightisation of the Christian Democratic EPP (the largest party in the European parliament), this could have a negative impact on hoped-for changes in EU governance, towards more efficient decision-making processes and the setting-up of some form of fiscal transfers between member states, via the possible issuance of European bonds.
Considering that hopes of a better-functioning EU were triggered by the unanimity around the need for a common defence programme, we should also note that any such development would probably come at the cost of optimal economic growth. Defence spending is indeed known to have a multiplier effect of only 0.4-0.5, meaning that it slows down potential growth. Investment in infrastructure and digital technology, for instance, has a much larger positive effect. And since, after all, every euro can be spent only once, there is a risk of cuts in social security spending, which could serve to further fuel the right-wing populist mood of the population.
Historian Yuval Noah Harari draws an interesting parallel between the proliferation of nationalist governments today and the medieval ages, when each lord built his own castle and ran his own economy. Eventually, though, such “local” economies reached their limits and the only way to extend them was to attack the neighbouring castle. Put differently, the risk of territorial conflicts is liable to increase considerably over the coming years if policies remain unchanged – not a happy prospect but one that President Trump has already alluded to when expressing interest for Greenland, the Panama Canal and Canada. The same can be said of Russia wanting to annex Ukraine, and of China wanting to annex Taiwan.
Against such a risky and uncertain backdrop, how should investment portfolios be positioned? With capital preservation as our main focus, we continue to advocate highly diversified exposures between asset classes, as well as across regions, sectors and currencies. Within the currency space, we maintain our overweight position in the euro and underweight position in the US dollar for the time being, and also look out for other diversification opportunities (JPY, GBP, CHF and emerging currencies?). As for bond markets, given deteriorating public finances everywhere, we are mainly looking to bonds of large companies with high credit quality (investment grade rating) as an interesting alternative to sovereign debt.
