After a generally positive start to the year for equity and bond markets, the overall picture has profoundly changed since the end of February. The joint military operation by Israel and the United States against Iran, which began on February 28, quickly took on a regional dimension, with reciprocal retaliations, attacks on US military bases in the region, but also attacks on strategic and energy infrastructures, leading to a marked deterioration of security conditions in the Persian Gulf.
From the very first hours, market attention focused on the risk of physical disruptions to energy supplies and the functionality of the Strait of Hormuz, a crucial hub for the transit of about 20-25% of global trade in oil, petroleum products, and liquefied natural gas. The most affected geographical area in terms of price increases is Asia, given that crude exports from Gulf countries are mostly absorbed by countries such as Japan (over 90% of petroleum product imports), India (50-55%), and China (45-50%). However, Europe is not immune either. The price of Brent – the most relevant quotation for the European market – quickly surpassed the $100 per barrel threshold, momentarily even approaching $120. This represents an increase of over 70% compared to the levels at the beginning of the year and over 50% since the end of February, a movement comparable only to the oil crises of 1974 (OPEC embargo) and 1979 (Iranian revolution) and the first Gulf War, with Iraq’s invasion of Kuwait.
At the same time, gas prices in Europe have recorded sharp increases, fueled by news of damage to key facilities in the Gulf and fears of prolonged blockages or slowdowns in liquefied natural gas supplies to the continent. Low stock levels in Europe after a harsher-than-expected winter – with the exception of Italy, where stocks are in line with previous years – contribute to the price rise.
In this context, hypotheses of a coordinated release of strategic crude oil reserves had a partial and limited impact, unable to fully mitigate volatility and price tension, as investors question the duration of the Strait of Hormuz closure and the reduction in crude production. The war’s time horizon and its geographical evolution have thus become the main short-term macroeconomic variable, capable of influencing expected inflation, monetary policies, growth expectations, and financial asset valuations.
The worsening conflict and the surge in energy product prices have progressively impacted financial markets. In early March, equities in Europe, Japan, and Emerging Markets recorded the most significant declines, while the US market showed greater resilience, with a nearly unchanged trend until mid-March once the impact of the dollar appreciation was considered. However, in the last sessions of last week, even the US index fell, marking losses of over 3% since the beginning of the month. Europe recorded declines close to 10%, wiping out the gains from the start of the year, while Japan and Emerging Markets, despite losses around 7-8%, remain positive year-to-date.
The interest rate channel has been one of the main amplifiers of the shock. Indeed, fears of an inflation shock pushed up expectations for central bank rates, and market rates moved sharply higher, in a typical bear flattening movement – meaning there was a more marked increase in short-term rates compared to long-term ones.
In the United States, the 2-year rate rose by over 50 basis points, while the 10-year nearly reached 4.4% at the close of last week, up by 43 basis points since the end of February. For the 10-year, this is the highest level since the end of July 2025.
Even more marked increases occurred in Europe. The German 2-year rate rose by 66 basis points, the Italian 2-year by as much as 83 basis points, of which over 50 in the last three sessions of last week. The German 10-year rate rose by 39 basis points, breaking above 3% – precisely 3.04% reached last Friday. This is the highest level since June 2011, and we are therefore already above the 2023 levels, when core inflation ranged between 5% and 6% compared to the current 2.5%.
In this context of extreme geopolitical tension, public and private spreads have risen. The differential between 10-year BTPs and Bunds returned above 90 basis points (from 63 at the end of February), with Italy perceived as higher risk due to its greater dependence on fossil energy sources. In the credit sector, the Investment Grade bond spread rose by 8 basis points since the end of February – a relatively limited increase reflecting the generally good fundamentals of companies – while the High Yield sector saw a more significant increase of 39 basis points. Emerging market bonds also suffered, particularly those of energy-importing countries.
A word should also be spent on so-called safe-haven assets which, in this context, have shown less linear behavior compared to the past. On one hand, the dollar appreciated – moving from 1.18 to 1.14 against the euro – thanks to the energy independence achieved by the US in the last decade; on the other hand, we saw a sharp depreciation of gold, whose prices fell from 5300 to 4500 dollars per ounce, one of the largest monthly drops in the last 15 years. Factors weighing on gold include profit-taking after strong gains in recent months, but also the sharp rise in interest rates and prospects of a less accommodative stance by central banks to combat the likely inflation surge.
Looking to the coming weeks, geopolitics will maintain a central role. The conflict between the USA, Israel, and Iran has produced an energy shock that quickly transmitted to rates, equities, and volatility, changing the reference regime. In the absence of clear signs of de-escalation and reassurances about the integrity and full operation of energy infrastructures in the Persian Gulf, it is difficult to imagine a normalization of risk premiums. Historically, stock prices tend to suffer in the first three months following the start of an oil shock, with a gradual recovery over 6-12 months. However, for this to happen, a normalization of the geopolitical framework and a recovery in crude supply are necessary. A prolonged period of high energy prices, on the other hand, would negatively impact inflation and growth prospects, weighing on financial market performance.
WAITING TO UNDERSTAND THE NEGATIVE IMPACT ON GROWTH
Let us now consider what the impacts on growth might be. For the moment, analysts’ estimates do not reflect any negative impact. The numbers, in fact, indicate growth for 2026 of +1.2% for the Eurozone and +2.5% for the United States. However, according to estimates from the IMF and OECD, a 10% increase in oil prices usually has a negative impact of 0.2%-0.3% on growth within 12-18 months. At this moment, the price of oil has risen by about 60% compared to the average of the last year. It should be noted, however, that in real terms, the price of oil is still about 25% below 2022 levels (post Russian invasion of Ukraine) and about 50% lower than the peaks of 2008.
According to scenarios presented by the ECB last Thursday, the impact on Eurozone growth could settle between -0.7 and -1.0 percentage points by 2027 in the case of oil prices between $115-120 per barrel. A further increase to around $140-150 and persistent supply limitations could lead to a growth loss of up to 1.5% – 2.0%, with a concrete risk of recession. Similar scenarios apply to the Fed and growth in the United States, although greater US energy independence may mitigate adverse impacts.
Given the high geopolitical uncertainty and the potentially broad negative impact on growth, it is of little help to look in detail at growth indicators related to the pre-war period. Business confidence indices, both in the United States – ISM Manufacturing at 52.4, ISM Services at 56.1 – and in the Eurozone – PMI Manufacturing at 50.8, PMI Services at 51.9 – showed acceleration in February and were in positive territory compatible with growth around (for the Eurozone) or slightly above (for the United States) potential. The only downside was the weakness of the US labor market, with 92,000 jobs lost in February and unemployment marginally rising to 4.4%. The greatest risk to growth comes from rising energy prices, with a negative impact on household purchasing power and consumption. However, it is very difficult to precisely estimate this scenario, and upcoming geopolitical developments will play a key role.
THE OIL SURGE WILL PUSH OVERALL INFLATION, HIGH RISK OF SECOND-ROUND EFFECTS
Let us now discuss the inflation outlook. As with growth, uncertainties have increased significantly compared to last month. The most recent data showed a further slight decline in service inflation (and core inflation at +2.5%) in the US and inflation not far from targets for the Eurozone (with core at +2.4% year-on-year in February). Consensus estimates for 2026 saw overall inflation at +2% for the Eurozone and +2.7% for the United States. However, the geopolitical and energy shock will soon push these numbers upward.
In the current scenario, a significant upward revision of inflation estimates is expected in the coming months. The starting point is the energy component, which after having contributed significantly to the slowdown of inflation between late 2025 and early 2026, will soon again exert strong upward pressure on overall inflation numbers. Subsequently, second-round effects on components linked to oil prices are plausible, particularly on prices of food, transport, and some services characterized by high energy intensity. If the rise in energy prices persists, the main risk is a slower return of core inflation to target or even a new upward overshoot.
Speaking of more recent numbers, we see the scenarios published by the ECB last week. In the baseline scenario, which assumes a temporary increase in energy prices with oil around $90 per barrel, the impact on inflation would be contained and transitory, with a gradual return to target in the medium term. In the more adverse scenarios, however, with oil prices stably around $115–120, Eurozone inflation could rise to about 3.5%, significantly delaying the normalization process. In the most severe case, characterized by prices between $140 and $150 per barrel and persistent supply destruction, the ECB estimates that inflation could exceed 4% and remain high even in 2027, increasing the risk of second-round effects on wages and prices. This last scenario represents the main concern for monetary policy, as it would transform an initially temporary shock into a more structural problem for price stability.
CENTRAL BANKS: FED ON HOLD, 3 HIKES PRICED IN FOR THE ECB
Obviously, the monetary policy outlook is deeply conditioned by the war and the energy shock. In last week’s meetings, both the Federal Reserve and the ECB left interest rates unchanged, but with a significantly more cautious message than a month ago, strongly data-dependent and with growing attention to the energy channel and inflation expectations.
In the United States, the Fed kept the Federal Funds rate in the 3.5–3.75% range, emphasizing that the economic implications of the Middle East conflict are highly uncertain. The message from the FOMC and Powell’s press conference was that of a central bank aware that rising energy prices will have immediate effects on inflation but reluctant to anticipate conclusions on growth and the labor market until greater clarity on the shock’s duration emerges. The dot plot still shows, on average, a cut by the end of 2026, but market estimates are decidedly less accommodative. We have indeed moved from an expectation of 61 basis points of cuts by year-end (equivalent to 2-3 cuts of 25 basis points) to a 7 basis point increase, i.e., rates steady but with a slight chance of an upward adjustment.
The ECB, while leaving the deposit rate unchanged at 2%, also signaled a significant change in the risk balance. As previously mentioned, the official March projections were accompanied by alternative scenarios showing how a prolonged oil shock could significantly delay inflation’s return to 2%. In adverse and severe scenarios, inflation could rise well above 3% and remain high even in 2027. This leads to a necessary greater caution on the monetary policy front, despite the expected short-term growth slowdown.
Market expectations for the ECB clearly reflect this shift in orientation. While at the end of February the market priced in a 13 basis point cut, expectations now are for a 77 basis point hike, equivalent to three hikes by year-end. Bundesbank President Nagel – one of the most hawkish members of the ECB council – has hinted at the possibility of a first rate hike as early as April in case of a sharp price acceleration.
The coming weeks should provide more elements to understand the central banks’ next moves, but we are certainly facing a shift toward a less accommodative stance, particularly for the ECB, which seems inclined to prioritize price stability and anchoring expectations, accepting the risk of weaker growth rather than a new persistent inflation shock as occurred in 2022 and 2023.
FINANCIAL MARKETS AND OUTLOOK
Let us now turn to the outlook for financial markets and portfolio allocation.
Equity markets have shown high volatility, and there have been significant profit-taking on themes that had dominated markets so far, especially gold stocks suffering from the sharp decline in gold prices since the conflict began. Similarly, the bond segment has suffered heavy losses both due to the sharp rise in core yields and the widening of spreads, with Italian BTPs under pressure, while Investment Grade credit has shown more resilience.
The question all investors ask is whether we are facing a radical change in the underlying scenario compared to the generally positive one a month ago. The obvious answer is a big “it depends.” The longer geopolitical tensions and high energy prices persist, the greater the risk of a severe impact on growth and inflation, in a typical stagflation scenario (recession/stagnation in terms of growth and upward inflation pressures). This would be negative for risky assets, primarily the equity market. Conversely, a resolution of the conflict and normalization of oil prices would lead to a rebound in stock markets.
Looking at the history of past oil shocks, equity markets usually remain under pressure for 1-3 months from the start of tensions, then gradually recover over 6 to 12 months, although showing below-normal returns. To better understand recovery times, we can compare with the situation in summer 1990, with Iraq’s invasion of Kuwait led by Saddam Hussein. On that occasion, equity markets lost about 15% in the first three months – oil prices tripled – but then fully recovered losses after 7 months and continued upward over 12 months, thanks to oil prices returning to pre-war levels.
In such a volatile and deeply uncertain context, reducing active weights in the portfolio appears a sensible choice. Brief announcements by involved parties can cause violent and rapid market reactions, both negative and positive, as happened yesterday after President Trump’s announcement to delay further attacks on Iran’s electrical infrastructure. Any rebounds can be used to lighten risk positions in portfolios, while the use of options instruments seems preferable to position for a possible market rebound but also for a downward correction in interest rates.
Summarizing the portfolio positioning, we can say this:
On the government side, we adopt a neutral stance on duration, both in Europe and for the US curve. It will be important to assess the impact of the energy shock on inflation and central bank policies, with ECB hikes clearly on the table. The last weeks have seen a significant rise in inflation breakevens – i.e., market expectations of future inflation – favoring the outperformance of inflation-linked bonds. From now on, a normalization of oil prices would again favor nominal bonds.
Looking at individual countries, German Bunds (above 3%) and British Gilts (temporarily above 5%) offer already interesting entry levels for the medium term, although it is indeed difficult to fully understand the implications of the current oil shock. US Treasuries (currently around 4.40%) seem to partially price in a possible suspension of the Fed’s cut cycle, and fiscal risks – especially in an election year – cannot be ignored.
Regarding Italian BTPs, recent weeks have seen a repricing of recession risk and the consequent negative impact on public debt levels. Our country’s energy dependence is a weakness in this context, which the market is correctly pricing. However, the marked improvement in public accounts, with a deficit well under control before the outbreak of the war, should be remembered.
Completing the government sector, pressure on emerging market bonds, both in hard currency and local currency, should be noted. However, it is good to distinguish countries based on the impact of the oil shock and proximity to the conflict. Countries less affected by this crisis, such as Brazil, Colombia, and Mexico, have shown greater resilience compared to Eastern European countries or South Africa, which are more sensitive to rising oil prices.
Moving to credit, the European Investment Grade sector has shown great resilience, with very limited spread widening. We consider it appropriate to maintain an approach that maximizes remuneration (in terms of spread) per unit of duration, preferring medium-short maturities and quality bonds, while for increasing duration exposure we continue to prefer the government curve. The High Yield sector, although not showing marked corrections, appears more at risk in this uncertain context and therefore we recommend greater caution.
Concluding with equities, as mentioned, the high uncertainty about the conflict’s duration and its consequences in terms of growth (and secondarily in terms of corporate earnings) suggest a more balanced approach, avoiding significant active weights both in overall allocation and in geographic and sector positioning. We take any market rises as opportunities to reduce overweight positions, while we believe the wisest way to implement strategies for a market rebound is through options structures.
