Middle East conflict what it means for the global economy

After another week of conflict in the Middle East, we wanted to talk about how it can impact the global economic picture and financial markets. 

The standard view is that investors should look past geopolitics – that while the human cost of conflict is profound, the impact on financial markets can be much more muted. There may be short term volatility, but the right answer has generally been to stay the course and not to make major changes to portfolio positioning.

But as the conflict in the Middle East continues, we wanted to think about how it can impact the global economy. The easiest answer is through commodity prices. Prices for oil and natural gas have risen sharply over the past couple of weeks (see the chart of oil prices below), even if they’re still below where they were in the aftermath of the Russian invasion of Ukraine in 2022.

Higher oil prices are already impacting consumers. The chart below shows the price per gallon of gasoline in the US. Again, it’s well below where we were in 2022, but the increase has been notable. The longer gasoline prices stay high, the greater the impact on households in the US and elsewhere. The impact likely won’t be limited just to the price at the petrol pump. Sustainably higher energy prices can impact fertiliser and food prices, as well as the IT supply chain. 

We’ve already seen an impact in bond markets. The chart below shows the implied US policy rate for the end of 2026. At the end of February, investors were looking for two or more rate cuts in the US this year. Two weeks into the conflict, investors think we might be lucky to see one cut. In the UK and Eurozone, there is talk now of rate hikes in 2026. 

In the past, analysts might have suggested that the conflict represents a supply shock and so central banks should look past that. But in 2022, central bankers made similar statements and were criticised by many for not acting quickly enough to tackle inflation. Investors don’t expect them to make the same argument this time around. That’s impacted longer-dated bond yields, with ten year yields rising over the past couple of weeks (see chart below).

So where does this get us? We can see how the conflict is beginning to impact the global macro environment. And that impact will likely grow the longer the conflict continues. We’ve also seen weakness in both bonds and equities, as we did in 2022. The impact so far, we’d argue, has been quite muted. We think that’s partly because starting bond yields today are far higher than they were at the end of 2021. We think It also reflects the view that the conflict will likely be short-lived – at least in terms of the impact on energy prices. That’s an important assumption, and one we’ll continue to evaluate. 

For now, we continue to think that diversification is key. But diversification means more than just allocating between equities and ten-year government bonds. We’ve seen before, for instance, how duration can add volatility to portfolios in certain market environments. But we think we have a wide range of tools – via equities, currencies, credit, sovereign debt and commodities – to help manage portfolios through a period of higher volatility.