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Scenario Analysis: Surging Oil and Energy Prices
Institutional investors might be concerned that escalating unrest in the Middle East could push oil prices higher, as geopolitical risk has once again come into focus for this group. A sustained rise in energy costs may fuel inflation and weigh on economic growth, affecting portfolios. In this quick take, we use the MSCI Macro-Finance Analyzer to evaluate the impact of two energy-price shocks on the U.S. economy and financial markets.1
- 30% energy-price shock: Energy-price increases lead to higher inflation, with growth slightly below the baseline in subsequent years. U.S. equities decline by 5%, the Treasury yield curve shifts up by 30 basis points (bps) and five-year U.S. breakeven inflation rises by 50 bps.
- 60% energy-price shock and shallow recession: A larger energy-price shock, accompanied by a shallow recession, results in a 14% sell-off in U.S. equities. The one- and 10-year Treasury yields increase by 40 and 50 bps, respectively, while five-year U.S. breakeven inflation rises by 85 bps.
We used MSCI’s predictive stress-testing framework to propagate the broad market shocks from the MSCI Macro-Finance Analyzer to a global diversified portfolio consisting of global equities and U.S. bonds and real estate.2 Such a portfolio could decline by 3% under the 30% price shock and by 8% under the 60% price shock. All asset classes shown in the exhibit, except energy stocks and inflation-linked bonds, lose under both of our scenarios as a supply-driven energy shock leads to a rise in inflation and a positive correlation between equities and nominal Treasury bonds.3
The author thanks Will Baker for his contributions to this quick take.
Two scenarios for an energy-price shock
Portfolio impact under our scenarios
1 We used the MSCI Macro-Finance Model to model different trajectories for the U.S. economy. The MSCI baseline (opens in a new tab) as well as the stressed macroeconomic scenarios can be accessed via these links: 30% energy-price shock (opens in a new tab) and 60% energy-price shock and shallow recession (opens in a new tab).
2 Treasury inflation-protected securities (TIPS) are represented by the iBoxx TIPS Inflation-Linked Index provided by S&P Dow Jones Indices. U.S. Treasurys, equities and corporate bonds are represented by MSCI indexes. Private equity is represented by model portfolios. U.S. real estate is represented by the MSCI/PREA U.S. AFOE Quarterly Property Fund Index. The composite portfolio is 50% global equities (35% public and 15% private), 10% U.S. Treasurys, 10% TIPS, 10% U.S. investment-grade bonds, 10% U.S. high-yield bonds and 10% U.S. real estate.
3 The results are generated by using model correlations to propagate shocks to the portfolios, using MSCI's BarraOne®. MSCI clients can access the correlated BarraOne stress test here. A RiskMetrics® RiskManager® stress test can be downloaded from the MSCI Macro-Finance Analyzer (via the links above, by clicking the “Download” button).
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