In Summary
At the rig, energy has eased on de-escalation hopes but stays elevated. At the pump, refining is the bottleneck. After the US midterms and President Trump’s signal that further strikes on Iran are not needed, Brent is trading around USD90/bbl, down more than 20% from its late-October peak. Crude flows have almost returned to pre-war levels, but a geopolitical premium, higher freight costs and stock rebuilding is keeping prices elevated. We expect Brent to average USD100/bbl in Q4, lifted by the October peak, and fall close to pre-war levels, to USD73/bbl by end-2027. A Hormuz deal (guaranteed navigation, insurance and escorts, phased US sanctions relief for Iranian nuclear limits) would compress the premium further. European gas is averaging EUR85/MWh in Q4 and should fall to EUR45/MWh by end-2027, still 40% above pre-war levels. With about 3.5mn b/d of refining capacity offline and crack spreads at USD45-75/bbl, wholesale diesel is up 100-115% ytd (US pump +70%, Europe +35%) and should stay high until Q2 2027.
The shock reaches the shopping basket with a lag and compounds through food. Producer prices are up 6.3% y/y in the US and 11.1% in the eurozone, and China exports inflation (export prices +15% y/y) despite weak domestic demand. Food follows: eurozone producer prices peak around Q1 2027 and consumer food inflation later in Q2-Q3, with the temperature effects associated with a strong El Niño potentially adding up to +0.5pp to EU food inflation. Headline inflation therefore rises even as energy falls: the US goes from 4.0% to a peak of 4.3% in early 2027 (3.3% for the year), the eurozone from 4.0% to 4.4% in Q1 2027 (3.0%) and Japan from 2.1% to 2.2% (1.7%), against 2022 peaks of 9.0% in the US, and 10.6% in the eurozone. Emerging markets with weak currencies, and dependent on energy and food imports, are the hotspots (India, Philippines, Egypt, Nigeria, Türkiye). In a downside scenario with Brent staying above USD100/bbl, 2027 inflation could average 4.5% in the US and 4.8% in the eurozone.
Containment requires more tightening from central banks, but we don’t see AI triggering second-round effects. High near-term inflation expectations could feed into wage demands, but a wage-price spiral looks unlikely: US wage growth is 3.1% against a 2022 peak of 5.6%, eurozone labor markets are back to pre-Covid tightness, fiscal support is far smaller and real rates are at decade highs. We expect the Fed to hike three more times (Dec, Jan, Mar) to 4.50-4.75% before cutting to 3.75% by end-2028. The ECB goes to 3.00% (Dec, Mar) and then 2.25%, the BoE to 4.5% (Dec, Mar) and then 3.25%, and the BoJ to 1.75% (Dec, Mar) before holding. Emerging markets moved first, frontloading hikes that peaked in Q2-Q3 2026. South Africa, India, Philippines, Colombia and Czechia still plan more. Regarding whether AI capex and wealth effects build pent-up demand, as in 2022, we do not see it. We estimate AI adds only +0.3pp to US inflation in 2026-27 through investment, wealth effects and energy demand, before turning disinflationary as labor demand shrinks, wages are capped and productivity rises, though the timing is highly uncertain.
On Wall Street, bonds finally got the inflation memo while risky assets continue to shrug off the inflation scare. After the Treasury sell-off and repricing of Fed hikes this week, markets have caught up with our scenario. Our forecasts for long-term yields stay elevated: the US 10-year ends 2026 at 5.00% and 2027 at 4.75%, the Bund at 3.30% and 3.50%. Equities and credit, by contrast, rest on AI-driven fundamentals (US +14% in 2026 and +8% in 2027, Europe +15% and +9%, investment-grade spreads at 80-90bps) and are priced for perfection: higher inflation and rates could trigger a correction of up to 6% and 20bps of spread widening. In our downside, the Fed and the ECB would have to hike a couple more times and 10-year yields would jump to 6% in the US and 4.5% for the Bund, before getting back in check as growth would slow to 1.5% in the US and 0.4% in the eurozone in 2027. Equities would fall -8% in the US and -11% in the eurozone. Note that corporates have absorbed the hit so far through inventories and partial pass-through but about 1-2 points of profitability is at risk should energy prices stay elevated throughout 2027.
On Main Street, wages do not compensate, and the shock is spurring protests. Real wages are falling: US -0.9% y/y and -1.2% in the eurozone in Q4, so households lose purchasing power. Policymakers have cushioned the blow with fuel tax cuts and pump price discounts (Spain, Germany), energy bill caps (Italy), subsidies (Japan) and minimum wage hikes (Germany, France, Spain) but fiscal space is far smaller than in 2022. 75% of the Allianz Pulse survey respondents expect living costs to rise by more than 2% next year, and fears for job losses because of AI have surged, especially in Europe. Affordability protests have spread across France, Italy, Spain, Belgium and other countries, many of them in the “middle-resilience trap” of our Social Resilience Index, where prosperity coexists with polarization and weak reform capacity.