Weekly market commentary

The escalating Middle East conflict has triggered energy markets to now price in a prolonged disruption. That means higher costs, weaker growth, elevated bond yields and more persistent inflation — on top of pressures already bubbling under the surface. Risk assets don't reflect the macro damage that energy pricing implies, in our view. We dial down tactical risk and downgrade U.S. stocks as a result – but stand ready to adjust if political pressures put an end to the conflict.

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A market disconnect
Market performance since Mideast conflict and 2026 Fed rate expectations

The Middle East war has escalated, with attacks on energy infrastructure and a possible prolonged closure of the Strait of Hormuz global shipping channel. This has triggered a sharp repricing in energy markets that imply disruptions could last into next year. Year-end oil futures (the left bar in the chart) have rocketed upward – as have longer-dated contracts. The broad supply chain shock has jolted markets out of complacency about inflation pressures. Market expectations have flipped from the Fed cutting rates three times this year to veering toward a hike (see insert). Long-term government bonds have sold off, showing they are no longer the place to hide when conflicts trigger supply shocks and stoke inflation. The outlier? The S&P 500 is just 7% below record highs. We see a disconnect: A macro shock and hawkish reversal in policy expectations are not consistent with current stock prices.

Political pressures from higher energy prices could shorten the conflict, but there’s no tangible evidence yet of this happening. This means we have no basis to think market expectations for energy prices are too high. They currently imply a hit to global growth of roughly three-quarters of a percentage point, we estimate, alongside higher inflation. And things could get worse still. Markets have been jolted out of their complacent view of benign inflation as a result. Expectations for U.S. rate cuts have dissipated and swung toward multiple hikes in the euro zone and UK. Central banks held rates steady last week, but their maneuvering room has shrunk. Earlier this year, we thought a weaker jobs market might give the Fed cover for cuts. That window is closing fast. The Fed itself last week signaled the case for future rate cuts was materially weaker.

Energy infrastructure in focus

The energy shock is broader than a typical oil spike. Gas markets have been disrupted, and the near-closure of the Strait of Hormuz is feeding through to a wide range of production inputs. This amplifies the hit to growth, with Europe and Asia hit hard because of their exposure to imported energy, and ups inflation pressure. This is not an about-face for inflation, but an additional driver of the inflation outlook. That’s why we think higher yields are here to stay, even when the conflict ends. We are in a supercharged version of a world shaped by supply, where disruptions drive inflation and growth. Central banks are faced with a stark trade-off between preserving growth or reining in inflation.

All this leads us to trim risk on a tactical horizon. We turn neutral across equity markets for now because overall risk asset pricing is not consistent with the shock implied by energy markets. In fixed income, we stay underweight long-term Treasuries. We see yields rising as investors demand more compensation for holding long-term bonds amid high debt burdens. And the conflict has reinforced they are no longer a reliable buffer for geopolitical shocks or equity sell-offs. We favor less rate-sensitive short- and medium-term U.S. Treasuries instead. We upgrade short-duration European government bonds as a cash buffer, given the rapid repricing of rate hikes. We stand ready to adjust these calls. The conflict could de-escalate as economic and political pressures mount – even as the bar for this looks higher than in the conflict’s early days.

Our bottom line

We are dialing down tactical risk for now as an escalating Middle East conflict has caused energy markets to price a prolonged supply-driven shock that lifts inflation. We stand ready to reverse course quickly if the conflict de-escalates.

Market backdrop

Markets now expect the Middle East conflict to drag on. Brent crude oil rose 5% on the week, hitting $119 a barrel at one point. The Fed, the ECB and BOE held rates steady, and expectations for 2026 cuts evaporated in the U.S. and turned to multiple hikes in the UK and Europe. Yields surged to 3.89% and 4.39% on two- and 10-year U.S. Treasuries, respectively. The S&P 500 fell 2%, bringing losses since the conflict started to 6%.

We watch global flash PMIs for the first read on how the Middle East conflict is affecting activity. We expect PMIs to deteriorate as higher energy costs and uncertainty weigh on demand. It’s still too soon for the full inflationary impact of higher oil prices to show up in Japan CPI and PPI, we think.

Read our past weekly market commentaries here.