A world reshaped since March

At the start of 2026, the macro backdrop still suggested a gradual easing cycle. Since then, the Middle East conflict and Strait of Hormuz closure have sent shockwaves through energy markets, pushing oil to multi-decade highs. Easing, once near-certain, now feels distant. The question is no longer when cuts arrive, but whether tighter policy is required.

Understanding the shock

The impact of the Hormuz closure varies by economy, shaped by four factors: fossil fuel dependency and availability of alternatives; exposure to global fuel prices; the degree of counter-stimulus; and economic fragility entering the shock.

The baseline across most economies is higher inflation and weaker growth. That said, de-escalation remains the base case, key stakeholders are incentivised to seek a near-term resolution.

Is this 2022 all over again?

The natural reference point is the 2022 oil shock triggered by Russia’s invasion of Ukraine. But today’s starting point is materially different: labour markets are softer, wage bargaining power is weaker, and policy rates are already at or above neutral in several jurisdictions.

What matters now is not the absolute level of oil prices but persistence, pass-through into core, and second-round effects. A 2022-style material synchronised tightening cycle would require core inflation to re-accelerate and expectations to become de-anchored. Without that, the most plausible paths are “higher for longer”, or marginal insurance hikes.

Central bank outlooks

Central banks face an increasingly asymmetric trade-off: higher energy costs are lifting headline inflation, with potential second-round effects into food and broader prices and third-round effects into wages. Over time, however, elevated prices and constrained supply are more likely to translate into weaker real activity and slower growth.

Against this backdrop, most central banks are leaning into data dependency and a “wait and see” posture, using communication to signal vigilance without pre-committing to action. Starting points matter: the US and UK are already slightly restrictive, while the euro area is closer to neutral.

ECB: Cautious but moving towards action

The ECB held rates at its latest meeting, but communication has shifted. Europe’s high energy import reliance creates a difficult mix: rising headline inflation and slowing growth. Senior officials have flagged persistent inflation risks tied to energy and supply disruption and concerns that waiting for wage confirmation may mean reacting too late. Markets now price two to three hikes by year-end, with hikes priced for the June and September meetings. Our base case is more measured: 1 to 2 hikes, with the first move, we believe, coming in June, though outcomes remain highly state-dependent.

BoE: An active hold, with caution building

The BoE characterised its late April hold as “active,” signalling reluctance to tighten further without clear evidence of second-round effects. Governor Bailey has argued that the repricing since February (the removal of expected cuts), tighter financial conditions, the BoE’s slightly restrictive starting point, and weakening demand could together limit the need for additional tightening. Given the BOE’s need for evidence that energy costs are feeding into wages and domestic pricing, a June hike is highly unlikely and July might be too early for clear confirmation. The market has priced the first full hike by September and currently expects them to deliver around two hikes. Our base case: zero to one hikes in 2026.

Fed: Higher bar for easing, hikes are no longer a remote tail risk

The Fed held interest rates at 3.50–3.75% but the tone tilted hawkish as the Committee debated moving from an easing bias toward a more neutral posture. Inflation persistence is driving the hawkish narrative as tolerance for inflation overshoots wane, with a majority indicating further firming would be appropriate if inflation stays persistently above 2%. Previously priced cuts have been unwound and the distribution of outcomes has become more symmetric and hikes are no longer a remote tail risk. The bar for rate cuts has increased as the data mix provides very little justification for near term easing whilst the probability of hikes has risen if inflation does not improve. Our base case is an extended hold.

Exhibit 1: Policy rate expectations have adjusted higher with oil prices

UK political risk: An added complication

Labour’s significant losses in the 7 May local elections have reignited scrutiny of Sir Keir Starmer’s leadership. The resignation of Wes Streeting and Andy Burnham’s move into the Makerfield by-election have intensified pressure, with Angela Rayner also a key risk. Markets initially priced higher UK risk premia on concern a leadership change could shift Labour leftward and damage fiscal credibility.

Gilt yields moved sharply: the 10-year briefly rose above 5%, the 30-year approaching 6%, levels last seen in 1998. Risk premia have since partially eased but political clarity is unlikely before late summer, with fiscal clarity pushed to the autumn Budget. For the BoE, this complicates an already difficult environment: political uncertainty may suppress the appetite to hike while simultaneously pressuring the long end.

Key inflection points: the mid-June Makerfield by-election, a potential leadership contest concluding no earlier than September, and the autumn Budget.

Portfolio positioning

Our liquidity strategies continue to prioritise capital preservation and liquidity. The initial conflict period saw decisive action: Weighted Average Maturity (WAM) reduced, Weekly Liquidity Assets (WLA) increased. As central banks have helped manage the most prominent tail risks, investor confidence has gradually returned and WAMs have extended, though cash buffers remain elevated.

• EUR: Given current market pricing relative to our more dovish outlook, we continue to see value on the curve. We are targeting a more neutral WAM position given the state dependant policy outlook whilst maintaining high cash balances.
• GBP: The UK proves to be a more challenging environment to navigate but value remains on the curve. Our preference is for a marginally long WAM bias. But given the front ends susceptibility to bouts of volatility we deem is appropriate to restricting the overall WAM limit whilst maintaining a healthy cash balance.
• USD: Recent repricing of market expectations relative to our more neutral outlook makes longer dated issuance look attractive and creates opportunities to extend WAM. Given this background we deem a long WAM bias as appropriate at this juncture.

Conclusion

Central banks face an increasingly difficult trade-off: growth is slowing, but the inflation impulse from higher energy prices raises the risk of renewed inflation persistence. Markets have repriced aggressively and the balance has shifted towards “higher for longer” away from prior debate surrounding when 2026 rate cuts begin to is tighter policy is required.

Geopolitical uncertainty remains the dominant driver of volatility. Our base case is de-escalation and a reopening of the Strait of Hormuz, but timing is uncertain and risks are two-sided.

In this environment, we believe cash remains compelling, although outcomes depend on inflation and reinvestment risks. Higher all-in yields and a steeper curve reward disciplined liquidity management, while resilient fundamentals underpin investment-grade credit. We remain focused on capital preservation and liquidity, and will use any outsized risk-off moves as opportunities to lock in attractive yields.