Lessons from historic shocks, US-Iran ceasefire, and emerging opportunities

The Middle East conflict is delivering a serious – but not systemic – shock to markets. Higher energy prices and uncertainty are testing a global economy that started the conflict in solid shape, with cooling inflation and resilient growth. Our base scenario assumes a de-escalation that avoids more disruptive consequences. With this in mind, we discuss our portfolio positioning, distil lessons from historical adverse events and highlight emerging investment opportunities.

We still expect Brent crude oil prices to average around USD 90 per barrel over the next six months. Even allowing for a delay in prices normalising after the end of hostilities, this would imply a modest inflation setback and slower growth, rather than renewed inflationary pressures or a recession. While recent strikes have already damaged some regional energy infrastructure, global producers retain the ability to cushion the supply shock. They can do this by re-routing some capacity through inland pipelines, such as the Yanbu pipeline (‘East-West Petroline’) in Saudi Arabia, drawing on spare capacity from the Organization of the Petroleum Exporting Countries’ (OPEC), and releases from strategic reserves.

Our base case thus sees upward pressures on global inflation remaining contained. US growth should cool rather than contract, and inflation rise modestly. Our terminal rate expectations from the Federal Reserve stay broadly unchanged despite delayed rate cuts. The European Central Bank, on the other hand, is likely to act pre-emptively to keep inflation expectations in check. We now expect it to raise policy rates twice in 2026, starting in June, before reversing those moves in 2027 back to a 2.0% end-cycle rate.

Financial markets have already absorbed some of the energy shock. Global equities have fallen as much as 5%, led by deteriorating price-to-earnings ratios, and reflecting higher energy prices and uncertainties. This is visible in the volatility of interest rates across different maturity bonds, or discount rates. Markets have rebounded with the recent news of a ceasefire. Earnings growth revisions have continued to increase since the start of the conflict, and corporate bond spreads – or the difference in yields over those of sovereign bonds – remain stable, suggesting few growth concerns so far. This may change if the conflict resumes after the ceasefire, but to date, resilient growth seems consistent with recent market developments. Under our base scenario, and despite some further volatility, we do not expect a materially deeper equity market pullback.

…to date, resilient growth seems consistent with recent market developments

At this stage, US government bonds are unlikely to provide strong portfolio diversification. Short-dated bond yields remain sensitive to volatile inflation expectations. Meanwhile, longer-dated yields have been driven by higher real interest rates, in part due to a repricing of policy rate expectations. Furthermore, resilient growth expectations and a stable ‘term premium’ – or the yield compensation required to hold longer maturities – should limit the scope for yields to fall in our base scenario. We prefer select UK and Australian bonds, where valuations are attractive. We continue to see diversification benefits in gold. We expect the yellow metal to recover further after its recent consolidation, as US dollar strength fades and markets start to reverse recent monetary policy tightening expectations.

Historical precedents

Today’s geopolitically-led energy shock is often compared with the First Gulf War of 1990-91 and Russia’s invasion of Ukraine in 2022. Both events led to a substantial rise in energy prices, with the First Gulf War followed by a recession. However, a key difference from today’s conflict is the scale of disruption. The 1990-91 Gulf War was a classic supply shock, in which severe and protracted oil supply losses accumulated to around 1,200 million barrels over several months.

In contrast, current disruptions are much smaller when accounting for supply and demand offsets and likely total below 100 million barrels so far. At the current pace, it would therefore take several months for oil market disruptions to resemble the scale of 1990-91. Meanwhile, the 2022 energy crisis was driven more by natural gas shortages, creating an asymmetric impact that left Europe more exposed than other regions. Overall, today’s disruption has so far been less severe and more global than these prior events. Importantly, in real, inflation-adjusted terms, the price of oil today remains below the peaks of historic shocks.

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Examining two risk scenarios

The two-week ceasefire is good news, but uncertainties remain and it is worth examining the risk of re-escalation and a sustained inflationary impact. If the conflict persists longer than expected, the balance of risks would shift towards more adverse outcomes. While not our main scenario, a prolonged oil supply disruption could push prices towards USD 115 per barrel over six months, threatening an inflationary slowdown. In this scenario, inflation would rise more significantly, while higher energy costs would weigh on consumption and corporate margins. Equity performance would be subdued, with lower valuations and risks to earnings-per-share growth. US government bonds would struggle to offset equity market weakness, as inflation concerns would limit the scope for yields to fall and central banks may consider raising rates further (see chart 4).

If the conflict persists longer than expected, the balance of risks would shift towards more adverse outcomes

Such a scenario would echo 2022, when inflation was above central banks’ targets, pushing policymakers towards fast rate tightening to contain rising prices and inflation expectations. Bonds perform poorly in this type of environment. Only inflation-linked bonds would offer a degree of portfolio shielding, by compensating for inflation’s rise via indexed coupons.

In a more extreme scenario of conflict escalation, involving lasting infrastructure damage or wider regional spillovers, oil prices might approach USD 150 per barrel on average over nine months. This would likely trigger another surge in inflation, generating broad demand destruction and recessionary risks. Such a ‘stagflationary’ outcome would be reminiscent of past oil shocks, such as the First Gulf War. Equity markets would see significant stress. However, the flight-to-safety would broadly favour high-quality fixed income, as risks to economic growth would push yields lower. It would also support gold prices. In this scenario, government bonds would offer diversification properties as growth risks start to dominate inflation risks.

Inflation expectations and ‘second round’ effects’

For now, markets remain focused on the inflationary impulse from higher energy prices. The important question, however, is whether ‘second-round’ effects will emerge over time – notably through increases in wages, services inflation and inflation expectations. These dynamics would force central banks to keep monetary policy in ‘restrictive’ territory that curbs growth for longer, increasing the risk of a policy-induced downturn.

We are monitoring a number of indicators to gauge these effects. Corporate earnings revisions offer a measure of how analysts expect companies to absorb higher costs and weaker demand. Meaningful downward earnings revisions would signal rising growth risks. Wider corporate credit spreads would also point to increasing stresses beyond equities.

The important question, however, is whether ‘second‑round’ effects will emerge

It is also important to monitor the evolution of nominal interest rates, through breakeven inflation rates, which measure the inflation rate priced into government bond markets, and real interest rates. The latter reflect growth expectations and the true cost of capital stripped of inflation. A sharp and sustained rise in long-dated breakeven inflation rates alongside stable real rates would point to more persistent price pressures, rather than a temporary energy-driven shock. In such an environment, discount rates used to value future cash flows would rise, as investors demand higher compensation for inflation uncertainty and policy risk.

We also track terminal rate expectations – the peak policy rate implied by markets – as a barometer of how central banks’ reaction functions are being repriced. A higher terminal rate would tighten financial conditions further, weighing on equity valuations and translating into lower price-to-earnings ratios, even before earnings expectations are revised lower.

Portfolio positioning and emerging opportunities

In our base case, we expect equities to play a valuable role in portfolios, and we favour quality and resilience. Regions and sectors with strong pricing power, robust balance sheets and reliable cash flows are better placed to navigate temporary cost pressures. We keep global equity allocations at neutral levels. We continue to hold selective exposures to cyclical regions, retaining an overweight in Japan, where we see an opportunity for valuations to rebound if the oil price normalises further. Within emerging markets we also prefer South Korea and China, and information technology among sectors. We balance these exposures with a preference for high quality dividend stocks, and additional sector preferences for healthcare and utilities.

Government bonds, in contrast, offer limited diversification in our base case. With inflation still volatile and US fiscal concerns potentially amplified by the cost of the war, ‘term premia’ are likely to stay high. We prefer short-dated maturity bonds in the US and selective exposure to UK and Australian bonds. We retain our preference for emerging market bonds denominated in US dollars over developed market sovereign bonds. Inflation-linked bonds can temporarily play a role in portfolios if inflation expectations rise further, but their beneficial impacts would fade once oil prices stabilise as we expect in our base scenario.

Portfolio flexibility is key in the current crisis

Gold remains a key strategic diversifier across both our base case and risk scenarios. Near term, we see opportunities for the precious metal to benefit from the unwinding of market expectations of US monetary tightening and an eventually weaker US dollar.

In risk scenarios, gold’s role as a store of value and hedge against geopolitical risks and policy uncertainty becomes more pronounced. Historical geopolitical shocks show that gold performs best either when real rates fall sharply or when confidence in major currencies is challenged. These conditions would prevail in a ‘stagflationary’ context, and even more so in a recessionary scenario. Gold should therefore provide diversification under inflation as well as growth shock scenarios. We maintain a small gold overweight in portfolios.

The value of alternative portfolio diversifiers depends on the nature of the shock. Commodities and commodity-linked currencies perform well in an inflationary slowdown but tend to suffer once growth risks dominate. Corporate bonds can continue to generate income in our base case, particularly in higher quality bonds, but are more vulnerable if spreads widen sharply.

Portfolio flexibility is key in the current crisis. While our base scenario remains that the conflict creates manageable economic impacts, the range of plausible outcomes is wide, and markets shift rapidly on new information. By monitoring the interaction between inflation expectations, growth momentum and monetary policy pricing indicators, we are ready to adjust portfolios proactively, and also to seize opportunities if progress in negotiations looks more positive.

Maintaining diversified portfolios, favouring quality and keeping effective diversifiers in place remains, in our view, the most robust response to an uncertain geopolitical and macroeconomic landscape.