Chief Market Strategist, Asia Pacific
In Brief
- APAC investors are concerned that elevated energy prices could bring back the stagflationary threat of the Russian invasion in 2022, where both stocks and bonds corrected sharply
- The difference in phases of economic cycle and monetary policy stance imply a less aggressive spike in inflation and less significant drawdown for fixed income
- However, this disruption to supply of energy could disproportionally impact Asia Pacific more than compared to the Russia-Ukraine war
As the U.S.–Iran conflict enters its fourth week, our conversations with APAC clients highlight the growing scepticism that the economic and market impact will be only short term. The concern is that oil and gas supply disruptions in the Gulf could persist due to damaged energy infrastructure or the absence of a credible off‑ramp for either side. This fear is reinforced by Iran’s attack on Qatar’s liquefied natural gas (LNG) facilities, which could remove 13 million tons of LNG processing capacity for several years. The interaction between Washington and Tehran has remained fluid and this could add to short-term market volatilities depending on the narrative from U.S. President Donald Trump.
Elevated energy prices—and the subsequent hit to production, especially in Asia—could revive stagflation concerns, drawing parallels to the 2022 Russian invasion of Ukraine. While our base case remains that both sides have strong reasons to de‑escalate in the coming weeks (see our previous article), it is still worth examining how today differs from 2022 and what this implies for portfolios.
2022 was a perfect storm of inflation
Higher energy and food prices from the Russia–Ukraine war were only one part of the inflation surge in 2022. As the global economy emerged from the pandemic, pent‑up consumer demand and supply bottlenecks in services (hospitality, airlines) also pushed prices higher. Aggressive fiscal support during the pandemic and exceptionally low interest rates added fuel to this inflation momentum.
By contrast, in 2026, global demand is stable but far from a full‑fledged recovery. Some governments, such as the U.S., with tax rebates, have provided selective fiscal stimulus, but it is not universal. Most importantly, central banks have been tightening for 3–4 years, and real policy rates in many developed and emerging economies have moved from deeply negative toward zero or slightly positive. For reference, the real fed funds target rate was -5.35% in February 2022, peaked at 2.74% in mid‑2024, and is now about 0.7% (Exhibit 1). The demand side of the inflation equation is therefore less problematic in 2026.
In sum, one of the biggest differences between 2022 and 2026 is the starting point for monetary policy. The ultra‑loose stance of 2022, designed to protect the global economy from the pandemic, had to be tightened rapidly to rein in inflation, creating a very challenging backdrop for both equities and fixed income.
At the Federal Reserve March FOMC meeting, the median policy rate projection for 2026 still implied one cut this year; 7 of 19 members expected no change, while the rest anticipated at least one cut. Australia has raised its policy rate by 50bps in the past two meetings, and the latest Bank of England and European Central Bank meetings took on a more hawkish tone. The Bank of Japan is also set up to hike rates this summer to tackle its domestic inflation challenge. That said, the magnitude of tightening of developed market central banks, if it takes place, is likely to be modest compared to 2022 given the modest easing in this cycle.
A larger impact on Asia than the 2022 oil price spike
The global surge in energy prices meant everyone paid more for oil and gas. But the physical disruption in volumes required a more significant—and arguably more costly—adjustment for businesses and consumers.
In 2022, Europe bore the brunt. Before the invasion, Europe imported 20-30% of its oil and petroleum products and 40-50% of its natural gas from Russia via pipelines. Sanctions against Russia forced Europe to find alternative suppliers quickly, although the cutoff arrived in phases rather than all at once.
In the current conflict, it’s ships that matter more than pipes, more than 80% of the oil and gas transiting the Strait of Hormuz is destined for Asia. For oil importers like Japan and South Korea, more than 60% of oil imports come from the Gulf. The abrupt nature of the disruption means these economies will rely on strategic reserves as a buffer. Fortunately, Northeast Asian economies such as Japan, South Korea and Taiwan typically hold at least 3–6 months of reserves. Even so, a prolonged disruption in energy and petrochemicals could delay semiconductor and electronics production or raise data-center build‑out costs. The region’s reliance on natural gas from the Middle East, and relatively low level of inventory given storage challenges, could be a more immediate concern, especially given the more sustained supply disruptions.
Portfolio construction
Exhibit 2 shows asset performance from the start of the Russia–Ukraine conflict until oil prices fell below USD 100 per barrel, and then six months thereafter. During the period of elevated oil prices, both emerging market (EM) equities and fixed income struggled, while developed market equities recovered lost ground more quickly. Within fixed income, U.S. corporate credit outperformed government bonds as credit spreads tightened. EM equities also suffered from a stronger U.S. dollar. Gold also underperformed during this period, which mirrors its performance in the past three weeks.
Once oil fell below USD 100 per barrel, EM and Asian equities rebounded, aided by a mild U.S. dollar pullback. Given the more hawkish monetary backdrop with central banks rapidly normalizing their policies, fixed income continued to underperform.
Since the start of the U.S.–Israel joint airstrikes in late February, markets have experienced significant volatility, especially in select Asian markets and in oil. Both stocks and bonds have corrected over the past three weeks. This pattern could persist in the near term if the Strait of Hormuz remains obstructed, the U.S. does not de‑escalate, or Iran continues to attack military targets or energy infrastructure in the region. Investors’ preference for liquidity could be the dominant short-term theme.
That said, as noted above, today’s point in the economic and monetary cycle suggests any fixed‑income drawdown should be less severe. Central banks are more likely to hold rates steady and wait for conditions to stabilize than to rush into aggressive hikes. It is also worth remembering that global growth momentum was stable before the conflict began, supported by AI capex.
A decline in energy intensity across economic activity and more diversified energy sourcing—for example, China’s increased renewable electricity generation—should help cushion the blow from higher oil and gas prices. As oil flows to Asia eventually resume, investors should reconnect with the positive momentum from data‑centre component demand and assembly. There are also longer‑term implications, including a potentially higher risk premium for Gulf energy if the Strait of Hormuz blockade risk persists, and a renewed focus on renewables to reduce fossil‑fuel dependence.
Alternative assets, especially infrastructure and transportations, historically have provided stability during periods of high geopolitical tension and rising energy prices. This is partly because some infrastructure’s revenue is inflation-linked. Despite the blockade in the Strait of Hormuz, global shipping traffic remains relatively resilient, especially as energy importing economies look for alternative routes to meet their domestic demand.
As mentioned earlier, investors may demand liquidity in the near term given geopolitical and economic uncertainties. There should also be a preference for high quality assets, such as investment grade corporate bonds and companies with strong balance sheets and profit margins that are less correlated with higher energy costs.
It is important to remain rational during this period of geopolitical volatility, especially as sentiment is easily influenced by news flows. The beginning of the end of this conflict, when it comes, could see a robust recovery that could be difficult to time, which requires investors to stay invested. Reducing risk exposure by rising allocation to fixed income and defensive sectors during periods of high volatility makes sense. Yet, eliminating risk exposure altogether by holding too much cash risk underperforming when the turnaround takes place.