Echoes of the Past: A Playbook for Today’s Markets

Tensions had been building. Military assets were being amassed across the Middle East. Despite ongoing diplomatic talks, the US launched a swift air campaign, destroying key air defenses and command-and-control centers. Oil prices surged on the outbreak of hostilities.

While, to most, this would be reminiscent of the ongoing Middle East conflict, I am, of course, referring to Operations Desert Shield and Desert Storm in 1990.

History doesn’t repeat itself, but it often rhymes. There are parallels between 1990 and today that may prove instructive for the economy and markets as we try to gauge the path forward.

First, the US economy. In the run-up to the 1990 Gulf War – roughly from 1987 through March 1990 – growth was solid, with job creation averaging about 200,000 per month. Yet credit availability was starting to tighten, even as household debt-to-income ratios climbed to multi-year highs, particularly among lower-income households. Against this backdrop, the Fed met in March 1990 at one of its regular FOMC meetings. By then, nonfarm payrolls were decelerating and barely positive. Hostilities in the Middle East were underway, and oil prices were expected to push inflation higher. Weighing the risk of higher inflation against a cooling labor market, the Fed chose to hold rates steady.

Oil prices soon spiked – soaring from about US$17 per barrel to nearly US$40. The shock helped tip the US economy into recession, with unemployment rising from around 5% in March 1990 to 7.3% by the end of 1991. Despite the jump in headline inflation, the Fed ultimately ‘looked through’ the supply-driven price shock and slashed rates aggressively from late 1990 through 1992. Ten-year Treasury yields tumbled from roughly 9% to 6.6% by the end of 1992.

Fast forward to today. Our base case is that the US will avoid recession and achieve a soft landing as the Middle East conflict moves towards some form of resolution in the coming weeks. As in 1990, a brief conflict can produce a transitory, oil-driven inflation bump. We expect the Fed to look through a temporary price spike and refocus on a decelerating labor market once large-scale hostilities end. Policymakers are likely to stay on hold at least through the first half of the year, but if the US labor market continues to soften, cuts could come into play in the second half.

There is, of course, a meaningful risk that the conflict drags on – we assign a 30% probability to a prolonged confrontation. In that scenario, the Fed may temporarily sound more hawkish to guard against inflation expectations, but eventually, it would likely need to support a weakening economy as recession risks mount.

The parallels between the 1990 Gulf War and the present-day Middle East conflict are striking and hard to ignore. Ultimately, history remains our best guide for navigating an uncertain future.

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