Global Economy Risk Assessment
A Narrow Path Through Another Oil Shock
By The Better Policy Project | July 9, 2026
A Mounting Storm for the Global Economy
The global economy is once again facing a difficult combination of risks: oil prices have eased from their recent highs, but the underlying geopolitical and supply-side vulnerabilities have not disappeared. The recent escalation between the United States and Iran briefly raised fears of a major disruption in the Persian Gulf, where around 20% of globally traded crude is produced and transported. Since then, prices have declined as markets priced in a higher probability of an interim U.S.-Iran agreement and a gradual reopening of export channels.
But this retracement should not be confused with resolution. The improvement depends on the deal being finalized, implemented, and followed by a real normalization of shipping flows, export infrastructure, and inventories. The global economy is therefore moving through a narrow path: one where oil supply gradually recovers, inflation continues to ease, and growth avoids a sharper slowdown.
Oil Prices Have Fallen, But the Risk Has Not Disappeared
Oil prices responded quickly to the changing conflict narrative. During the escalation phase, markets priced the possibility of a prolonged disruption to Persian Gulf production and transit routes. More recently, prices have declined as the probability of a U.S.-Iran agreement increased.
However, the oil market remains vulnerable. Higher fuel prices and product shortages have already weakened demand, refinery runs have been cut across several regions, and inventories have been drawn down rapidly, including through emergency government stock releases. This means that the market has fewer buffers if negotiations fail or if supply normalization takes longer than expected.
Oil prices have declined as markets priced progress toward a U.S.-Iran deal, but a breakdown in negotiations could still trigger a renewed and persistent price spike.
Source: IEA
Against this backdrop, three global scenarios are considered, differing primarily in the durability of the oil shock and the strength of the supply-side response.
The Market Reference Scenario assumes that the interim U.S.-Iran agreement holds, oil supply gradually normalizes, and the recent decline in crude prices proves durable. In this case, the inflationary impulse fades over time, global disinflation continues, and growth moderates without a sharper downturn.
Case A: Renewed Stagflationary Pressure assumes that negotiations break down or implementation is delayed, preventing a full recovery in Gulf oil flows. With inventories already drawn down and spare capacity unable to fully replace disrupted supply, oil prices rise again and remain elevated. This would delay disinflation, weaken real activity, and force central banks to maintain tighter policy for longer.
Case B: AI-Driven Productivity Upside assumes that the oil shock fades more decisively while stronger AI-related investment and productivity gains raise potential output, especially in the United States. Under this scenario, stronger supply capacity supports higher growth with less inflationary pressure, allowing inflation to return toward target faster.
Across all scenarios, the central uncertainty is whether the recent improvement in oil prices reflects a durable normalization of supply conditions or only a temporary repricing of geopolitical risk. The key constraint is that reduced inventories, limited spare capacity, and the concentration of oil production in the Persian Gulf make the global economy vulnerable to renewed disruption.
United States
The U.S. economy remains resilient, but financial markets appear increasingly optimistic. Equity prices have continued to rise on expectations of AI-driven productivity gains and investment spending, while BAA credit spreads remain compressed. This suggests that markets may be underpricing downside macroeconomic risks.
Inflation signals are also mixed. Some underlying measures have cooled, supporting the case for gradual policy normalization. But sticky-price inflation remains above target, and the labor market still looks firm enough to keep wage and services inflation risks alive. In this environment, a rapid easing cycle would be difficult to justify without clearer evidence that inflation is returning sustainably to target.
Elevated equity valuations and compressed credit spreads suggest that financial markets may be underpricing downside macroeconomic risks
Source: FRED
Euro Area: The Hardest Policy Dilemma
The euro area faces a sharper stagflationary trade-off. The renewed energy shock is arriving before inflation expectations have fully normalized. This gives the ECB less room to simply look through higher energy prices, especially if households and firms begin to treat inflation as more persistent.
Domestic cost pressures remain important. The labor market is still tight, wage growth is gradually moderating, and weak productivity has kept unit labor costs elevated. This is particularly relevant for services, where labor costs make up a large share of total costs and inflation remains sticky.
At the same time, growth remains weak and uneven. Spain continues to outperform, while Germany, France, and Italy remain more fragile. This leaves the euro area exposed to both sides of the shock: renewed inflation pressure and weak underlying demand.
Europe’s growth outlook remains uneven, with Spain still outperforming while core economies remain weak and increasingly reliant on fiscal support
Source: Eurostat
China: Strong Exports, Weak Domestic Demand
China’s growth momentum is expected to moderate after a strong start to 2026. Real GDP expanded solidly in the first quarter, supported by exports, policy measures, and high-tech manufacturing. But activity softened at the start of the second quarter, especially in energy-intensive sectors exposed to higher oil prices.
Domestic demand remains the main weakness. Retail sales have softened despite trade-in programs, fixed asset investment has weakened, and real estate investment remains deeply negative. Falling house prices, excess capacity, and weak developer activity continue to weigh on confidence.
Inflation pressures are also uneven. Consumer price inflation remains contained, reflecting weak domestic demand. But producer price inflation has risen, showing that the energy shock is feeding more directly into industrial costs than household prices.
Producer prices show stronger energy-related pressure than consumer prices
Source: Eurostat