Oil shock means inflation and volatility – unless Iran conflict ends soon

Facing the shock

Markets are attempting, in real time, to internalise the macroeconomic implications of the Iran conflict. This process will endure until traders and investors can conclude that the worst is over. At the time of writing, there was no clear view of when that might be. 

The global oil market remains the focus. The price of Brent crude was $100 per barrel at the time of writing. That represents a 90% rise relative to the lowest oil price of the last year and a 66% increase compared to 13 March 2025. 

For the US benchmark, West Texas Intermediate, the numbers are 85% and 60% respectively. By the time you read this, these prices are very likely to be different.

For now, these are big moves. Not the biggest, but significant, nevertheless. A day after Russia’s invasion of Ukraine in 2022, the price of Brent crude was 112% higher than a year before. Since 1974, using monthly data, there have been 85 months in which the oil price was more than 50% higher than the same month a year earlier (just 18 times when it was more than 100% higher). 

On most, but not all, of those occasions US inflation rose to 4% or above. Equivalent moves in the natural gas price and forecasts for European inflation are expected to send European interest rates higher. A second inflation shock after 2021-2022 would be potentially very damaging for markets and living standards.

Inflation on deck

Higher inflation, through the energy channel, will negatively impact consumers’ real incomes and business profitability. The longer that goes on, the worse the growth outlook becomes (lower consumer and business investment spending). 

The oil inflation shocks of the 1970s and 1980s were quickly followed by recessions. One could argue the increase in interest rates (inflation concerns) and the increased volatility in equity prices and credit spreads (growth concerns) over the last week are consistent with this playbook.

How long these market reactions persist and what could come next in terms of returns very much depends on the longevity of the conflict and how quickly energy markets can rebalance. 

On the positive side

Is there a positive spin on the outlook? While oil and its derivatives (as well as gas, and other products produced in and exported from the Gulf), remain critical to the world economy, energy intensity has declined. The International Energy Agency estimates that the global economy produces 36% more GDP per unit of energy compared to 2000.¹

Efforts to achieve net zero carbon through investing in non-fossil fuel energy sources have helped reduce dependency on carbon fuels. In addition, the real price of oil has also fallen (in US dollar terms, deflated by core consumer prices, the oil price is about 25% lower in real terms compared to March 2022). 

Generally, in developed economies, energy is a smaller share of consumer price baskets than was the case 30 to 40 years ago - in the US, energy accounted for around 9% of the Consumer Price Index 40 years ago, compared to around 6% today. 

Of course, it is the price shock that matters in the short term but hopefully the kind of energy rationing that I remember as a child in the 1970s is a scenario we can avoid. 

The generally improved inflation backdrop that developed economies have experienced over that time should not be dismissed because of the post-pandemic inflation spike of 2021-2022. 

There is a good chance we will get through this and focus on 2% inflation again – not this year I admit – but in terms of long-run inflationary expectations. That would help contain any increase in bond yields and limit the damage to risky assets.

Not 1970s’ levels of inflation

Oil futures prices imply a relatively quick end to the conflict is expected. If G7 countries can successfully orchestrate the release of strategic oil reserves in the days ahead, this might bring some relief to the energy markets. 

In that case, the impact on global inflation would be limited. Inflation swap curves reflect that profile (it would be more worrisome if the inflation swap market priced in a permanently higher level of inflation, especially given social concerns about the cost of living). 

Persistently higher inflation flowing from an oil shock requires behavioural changes through the economy – higher wage growth, and core goods and services prices increasing faster. Markets are not pricing that in.

For bonds, much depends on how central banks react. Markets have essentially called an end to any further central bank easing. Yield curves have flattened as short rates have moved higher. However, yield levels across curves remain in ranges that have been in place for the past year. 

Bond markets, generally, have experienced very little drawdown so far (February’s software shakeout in equity markets was a much bigger deal for those asset owners). It’s hard to imagine central banks delivering rate hikes in this environment unless the inflation path turns out to be much higher than currently priced. 

The point is - and this is important for risk assets - interest rate volatility is expected to be higher again. 

Value in credit

An early resolution to market stresses should reveal some potential investment opportunities. Credit, in general, has been resilient. Spreads have widened but, in the US, and euro investment grade and high yield markets, they are only matching the highs reached as recently as the fourth quarter last year. 

Outright yields have moved back to levels seen in the first half of last year. This week saw a record day of US corporate bond issuance which was voraciously snapped up by investors. There is no sign of diminished demand for good quality investment-grade paper, despite media reports about issues in private credit. 

In the high yield market, which is closer to the private credit world in terms of leverage and mid-market exposure, technical factors are positive. Coupon payments to investors tend to exceed new issues, so reinvestment supports the market.  

However, rates are moving higher, and this will undermine fixed income returns in the near-term. Assets with less exposure to interest rate volatility, with perhaps more spread - and certainly with inflation protection – may offer some defence in the short term. 

The oil needs to flow again

Writing market commentary at times like this makes one a hostage to fortune. No-one knows how events will unfold in the coming days and weeks. But we can guess as to the impact. 

On a very simple level, disruption is being caused by a relatively small, but very important, choke point in the geography of the world economy. If safe passage through the Strait of Hormuz can be guaranteed – which appears to be an objective for the US military – then market tensions should ease. 

A reduction in attacks on port terminals, refineries, storage facilities and production would also be a good thing. 

However, on a bigger picture scale, investors need to think about two things. Firstly, in the short term, what if the conflict continues into several weeks, with a persistent reduction in global supply of oil, natural gas and its impact on markets? 

Secondly, a more philosophical question is whether this conflict marks an example of permanently increased geopolitical risk. Will a new world of competition for scarce resources, for control of trade routes and alliances, and surging demand for energy related to AI development, bring about a lasting increase in inflation risk premiums and interest rate volatility? 

Friction in international relations, increased resort to military action to meet political objectives, more protectionist trade policies, and shifts in capital flows could all lead to higher inflation and lower growth. 

This does not mean going back to the 1970s, but investors may have to think about how geopolitical risks affect longer-term asset allocation, by asset class, liquidity profile and country exposure. 

Performance data/data sources: LSEG Workspace DataStream, ICE Data Services, Bloomberg, BNP Paribas AM, as of 13 March 2026, unless otherwise stated). Past performance should not be seen as a guide to future returns.