Lessons from historical shocks, ceasefires, and emerging opportunities

The conflict in the Middle East is causing a serious, but not systemic, shock to markets. Rising energy prices and uncertainty are testing a global economy that entered the conflict in good health, amid receding inflation and resilient growth. Our base-case scenario anticipates de-escalation to avoid more disruptive effects. In light of these factors, we are reviewing our positioning, drawing lessons from historical events, and identifying emerging investment opportunities.

We still believe that the price of Brent crude will remain around USD 90 per barrel on average over the next six months. Even accounting for a delay in price normalization after the end of hostilities, this level would imply a slight pullback in inflation and a slowdown in growth, rather than renewed inflationary pressures or a recession. Although the strikes have already damaged some regional energy infrastructure, global producers retain the capacity to cushion the supply shock. They can do this by redirecting some of the flow through land-based pipelines, such as the Yanbu (East-West Petroleum) pipeline in Saudi Arabia, by mobilizing excess capacity within the Organization of the Petroleum Exporting Countries (OPEC), and by releasing their strategic reserves.

Our base-case scenario therefore anticipates that upward pressures on global inflation will remain contained. US growth is expected to slow rather than contract, and inflation to rise moderately. Our expectations for the Federal Reserve’s terminal interest rate remain broadly unchanged despite a postponement of rate cuts. The European Central Bank, meanwhile, is expected to act preemptively to control inflation expectations. We now expect it to raise its policy rates twice in 2026 – starting in June – before returning to a cycle-ending rate of 2.0% in 2027.

Markets have already absorbed some of the energy shock. Global equity markets fell by as much as 5%, driven by deteriorating price-to-earnings ratios, reflecting higher energy prices and uncertainty. This is evident in the volatility of interest rates across different bond maturities, or discount rates. Markets have rebounded following recent ceasefire announcements. Earnings growth forecasts have been revised upwards since the start of the conflict, and credit spreads—the difference in yield relative to sovereign bonds—remain stable, suggesting that growth is not a major concern at present. This situation could change if the conflict resumes after the ceasefire ends, but to date, the resilience of growth appears consistent with recent market developments. In our base-case scenario, and despite increased volatility, we do not anticipate a further decline in equity markets.

To date, the resilience of growth appears compatible with recent developments observed in the markets.

At this stage, US government bonds are unlikely to offer significant portfolio diversification. Short-term bond yields remain sensitive to volatility in inflation expectations. Meanwhile, long-term yields have been supported by rising real interest rates, partly due to revised monetary policy expectations. Moreover, resilient growth expectations and a stable term premium—the additional return investors demand for holding long-term bonds—should limit the potential for yield declines in our base-case scenario. We favor certain UK and Australian bonds, where valuations are attractive. We continue to see diversification benefits in gold. The precious metal should continue its rebound after its recent consolidation phase, as the strength of the US dollar wanes and markets begin to scale back their expectations of monetary tightening.

Historical precedents

The current energy shock, of geopolitical origin, is often compared to the first Gulf War of 1990-1991 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, the key difference with the current conflict lies in the scale of the disruptions. The 1990-1991 Gulf War was a classic supply shock, characterized by severe and sustained losses in oil supply amounting to some 1.2 billion barrels over several months.

Conversely, the current disruptions are far more limited once the compensating effects of supply and demand are taken into account, totaling less than 100 million barrels so far. At the current rate, it would be several more months before the oil market disruptions approach the magnitude of those of 1990-1991. Moreover, the 2022 energy crisis was further fueled by natural gas shortages, creating an asymmetric effect to which Europe was more exposed than other regions. Overall, the current disruption has, at this stage, been less severe and more globalized than these previous episodes. It is important to note that in real, inflation-adjusted terms, oil prices remain below the peaks reached during previous historical shocks.

Two risk scenarios under scrutiny

The two-week ceasefire is good news, but uncertainties remain, and the risk of re-escalation and the potential for sustained inflationary impact should be examined. Should the conflict persist longer than expected, the balance of risks would tip toward less desirable outcomes. While not our primary scenario, a prolonged disruption to oil supply could push prices up to USD 115 per barrel within six months and pose a risk of slowing inflation. In this scenario, inflation would rise further, while higher energy costs would weigh on consumption and corporate margins. Equity performance would be sluggish, with lower valuations and risks to earnings per share (EPS) growth. US Treasury bonds would struggle to offset the weakness in equity markets, as inflation concerns limit the potential for yield declines and central banks may consider raising rates further.

If the conflict persists longer than expected, the balance of risks would tip towards less desirable outcomes.

Such a scenario would echo that of 2022, when inflation exceeded central bank targets, prompting monetary authorities to accelerate tightening to control rising prices and inflation expectations. Bond performance suffers in this type of environment. Only inflation-linked bonds would be able to offer a degree of portfolio protection by offsetting rising inflation through indexed coupons.

In a scenario of a more extreme escalation of the conflict, leading to lasting damage to infrastructure or broader regional repercussions , the price of oil could average around USD 150 per barrel over nine months. This would likely trigger a new surge in inflation, causing widespread demand destruction and risks of recession. Such a stagflationary situation would be reminiscent of past oil shocks, such as that of the first Gulf War. Equity markets would experience significant strain. However, demand for safe-haven assets would largely favor high-quality bonds, as risks to economic growth would drive down yields while supporting the price of gold. In this scenario, government bonds could offer diversification properties, as risks to growth would begin to outweigh inflationary risks.

Inflation expectations and “second-round” effects

For the moment, markets remain focused on the initial inflationary impulse triggered by rising energy prices. The crucial question, however, is whether “second-round” effects will emerge over time, particularly through rising wages, services inflation, and inflation expectations. These dynamics would force central banks to maintain their monetary policy in “restrictive” territory, curbing growth for a longer period, which increases the risk of a policy-induced slowdown.

We monitor a number of indicators to assess these effects. Revisions to corporate earnings allow us to gauge how analysts anticipate companies’ ability to absorb higher costs and lower demand. Significant downward revisions to earnings would signal increased risks to growth. Widening credit spreads would also indicate increasing stresses beyond equity markets.

The crucial question, however, is whether “second-round” effects will emerge over time, particularly through rising wages, services inflation, and inflation expectations.

It is equally important to monitor developments in nominal interest rates, particularly through equilibrium inflation rates, which measure inflation priced into sovereign bond markets, as well as real interest rates. The latter reflect growth expectations and the true cost of capital adjusted for inflation. A sharp and sustained rise in long-term equilibrium inflation rates, coupled with stable real rates, would indicate persistent price pressures rather than a temporary energy shock. In such a context, discount rates used to value future cash flows would increase, as investors would demand higher returns to compensate for inflation uncertainty and monetary policy risk.

We also monitor terminal rate expectations—the implied maximum policy rate for markets—as a barometer of how central bank response functions are being reassessed. A higher terminal rate would further tighten financial conditions, weighing on equity valuations and resulting in lower price-to-earnings ratios, even before any downward revisions to earnings forecasts.

Portfolio positioning and emerging opportunities

In our base-case scenario, equities are expected to play a significant role in portfolios, with a focus on quality and resilience. Regions and sectors with strong pricing power, solid balance sheets, and reliable cash flow are better positioned to withstand temporary cost pressures. We are maintaining our overall equity allocations at neutral levels. We retain selective exposure to cyclical regions, with an overweight position in Japan, where we believe there is an opportunity for valuations to rebound if oil prices normalize further. Within emerging markets, we favor South Korea and China, as well as information technology at the sector level. We balance these exposures by favoring high-quality dividend-paying stocks and by supporting sectors such as healthcare and utilities.

In contrast, government bonds offer limited diversification in our base case scenario. Given persistently volatile inflation and the potential for US fiscal concerns to be amplified by the cost of the war, term premiums are expected to remain high. We favor short-term US debt and selective exposure to UK and Australian bonds. We maintain our preference for emerging market bonds denominated in US dollars over developed market sovereign bonds. If inflation expectations rise further, inflation-linked bonds may temporarily play a role in portfolios, but their beneficial effects are expected to fade once oil prices stabilize, as projected in our base case scenario.

Portfolio flexibility is essential in the current crisis.

Gold remains a key element of strategic diversification, both in our base case and risk scenarios. In the short term, the precious metal could benefit from the adjustment of expectations of monetary tightening in the United States and, in the long term, from a weakening of the US dollar.

In risk scenarios, gold’s role as a store of value and hedge against geopolitical risks and economic policy uncertainty is becoming clearer. Historical geopolitical shocks show that gold performs best when real interest rates fall sharply or when confidence in major currencies is shaken. These conditions would prevail in a stagflationary environment, and even more so during a recession. Gold should therefore be a source of diversification in the face of both inflationary and growth shocks. We maintain a slight overweight position in gold in our portfolios.

The value of alternative portfolio diversification instruments depends on the nature of the shock. Commodities and commodity-correlated currencies perform well during periods of inflationary slowdown but tend to suffer when growth-related risks predominate. In our base-case scenario, corporate bonds will continue to generate income, particularly high-quality bonds, but they become more vulnerable to significant spread widening.

Portfolio flexibility is essential in the current crisis. While the economic consequences of the conflict are expected to remain manageable in our base-case scenario, the range of possibilities is wide, and markets react quickly to news. By monitoring the interplay between inflation expectations, growth dynamics, and indicators of monetary policy pricing, we are prepared to proactively adjust portfolios and seize opportunities should negotiations progress more favorably.

Maintaining diversified portfolios, prioritizing quality and preserving effective diversification tools remains, in our view, the most robust response to an uncertain geopolitical and macroeconomic context.