The air strikes by the U.S. and Israel that began on February 28 are likely to be the key event changing market sentiment in 2026, even if the conflict de-escalates in the short term. As the conflict drags on and Iran continues to attack oil and gas production facilities and infrastructure in the Gulf region, the blockage of the Strait of Hormuz is not the only worry for businesses and investors.

We still see both sides having good reasons to look for a path to de-escalate. For the U.S., the cost of this conflict and higher gasoline and food prices are jeopardizing the Republicans’ chances of retaining their majority in Congress in the mid-term elections in November. For Iran, the new leadership may want to regroup and rebuild its civilian and military infrastructure after weeks of bombing.

However, intention does not always bring the desired outcome in military conflict, and this creates a two-branch decision tree that investors will need to balance between.

Smash that hike button?

Since the conflict began in late February, Brent crude oil has risen from USD 70 per barrel to as high as USD 118 per barrel, as Iran opted to block the Strait of Hormuz from most traffic and attack Gulf states’ energy infrastructure and civilian targets. Its volatility has been significant and this was partly driven by President Trump’s changing stance on how he wants the military operation to proceed.

Market performance since the start of the conflict already reflects one of these branches. As the conflict drags on, investors worry that elevated energy prices could persist longer than expected, leading to concerns about stagflation—a rise in inflation combined with weaker economic growth. Given the experience of high inflation in 2022 and 2023, markets are starting to price in rate hikes by some central banks, including the European Central Bank and the Bank of England, joining other central banks, such as those in Japan and Australia, which are already on a path of higher policy rates. The March Federal Reserve FOMC meeting saw a more patient stance by U.S. central bankers, given still well-anchored long-term inflation expectation, but the prospects of rate cuts later this year have also dimmed given the latest surge in gasoline prices.

As a result, both stocks and bonds corrected, as investors opted for liquidity given this uncertainty. Stocks are dampened by the risk of higher energy costs leading to profit margin compression for energy-intensive industries and weaker revenue growth as consumers and businesses spend less. Bond yields rose on the back of the risk of higher policy rates, as well as demand for a higher term premium to cover higher inflation and increased fiscal spending to protect consumers from the higher cost of living. In the case of the U.S., there is potential for more spending to replenish munitions and other military operations.

That said, it is important to stress that there are differences between 2022 and 2026. 2022 saw significant growth momentum as the global economy was recovering from the pandemic, and there was considerable pent-up demand, which added to inflationary pressure. Both fiscal and monetary policies were incredibly accommodative at the time, also leading to the risk of overheating. The spike in energy prices as a result of Russia’s invasion of Ukraine was only one contributor to the perfect storm of inflation in 2022. The demand-side pressure and policy accommodation are less prevalent in this round. This should imply a less severe drawdown in fixed income.

Peace dividend

The other branch of the possible outcome is where maritime traffic flows through the Strait of Hormuz uninterrupted again and energy production capacity steadily returns to normal. This would allow the global economy to return to the pre-war stable growth path, supported by artificial intelligence (AI) development. The second-round effect of higher inflation triggered by the rise in food and energy prices is likely to be more muted, and this would allow central banks to be more relaxed. This would bring us back to our core scenario for 2026, where risk assets, including equities and corporate credits, would perform well.

We have argued for some time that geopolitical events typically have limited long-term impact on investment returns, provided that investors have a well-diversified portfolio with income generation capacity. We still believe this to be the case despite the lack of clear objectives from Washington and a flurry of headlines.

There are also long-term considerations and consequences beyond the current conflict. Assuming there is no regime change in Iran, its ability to close the Strait of Hormuz may prompt energy and petrochemical importers to further diversify their sources. Governments could also refocus their efforts to invest in non-fossil fuel energy options, such as solar, wind and nuclear power. Gulf states’ decisions on future national defense could also have implications for how they allocate capital.

What does this mean for investors?

At the time of writing, the situation in the Middle East remains fluid. While the U.S. and Iran are looking to re-establish a diplomatic connection, military action continues. During periods of uncertainty, investors may opt to maintain liquidity and look for opportunities to bargain hunt, even though timing the market is incredibly challenging. We suggest investors stay invested, while focusing on high-quality credits, such as investment-grade corporate debt, and companies with strong balance sheets and resilient business models toward higher energy costs and supply disruptions.

Overall, we remain constructive on the global economy and the development of AI. Once we have some clarification on how this conflict could be settled, we would return to a more pro-risk stance in asset allocation. This favors equities and corporate credits.

We also remain constructive on U.S. equities. Investors should broaden their allocation toward sectors such as financials, industrials and healthcare, given the growth momentum. We also see opportunities in Asian equities that feed into the AI evolution, whether these are component makers in Taiwan and South Korea or Chinese companies that are supported by government policies to become self-sufficient in technology and other strategically important products.

For fixed income, high-yield corporate debt and U.S. dollar-based emerging market fixed income can generate yields for investors even as credit spreads are relatively tight. The uncertainties on fiscal policies could still persuade investors to remain short duration in developed market government bonds.

There remains a role for alternative assets, especially real assets such as infrastructure and transportation, as businesses will need to further diversify their energy sources, hence demanding more shipping capacity.

Global economy

• Concerns over stagflation rose as the U.S.-Iran war triggered a surge in energy prices, with Brent crude back above USD 100 per barrel for the first time since 2022. Gasoline and other energy prices in the U.S. and around the world have already risen in tandem. Some governments, such as China and Thailand, have imposed export bans on refined oil products. There has also been an immediate fiscal response, such as price caps in Malaysia and Indonesia, to dampen the negative impact on consumers.
• The U.S. Federal Reserve kept its policy rate unchanged at 3.50% to 3.75% in the March FOMC meeting. The statement and projections showed upward revisions to both growth and inflation, while the median path for rates in 2026 was left broadly intact, implying only very gradual easing. The short-term inflation risk from higher energy prices was clearly a focal point, with committee members preferring to wait and see, especially since inflation expectations remain well anchored. Elsewhere, the Reserve Bank of Australia raised policy rates by 25bps in March. The Bank of Japan is also hinting at another rate hike in the months ahead. The ECB and BoE have also tilted towards a more hawkish stance because of higher energy costs and the potential second-round effects on prices.
• China, meanwhile, navigated a complicated backdrop of weaker domestic demand, a still fragile property sector and external shocks from the regional war. At the “Two Sessions,” Beijing set a 2026 GDP growth target of about 4.5% to 5.0% and emphasized a shift toward higher quality, more sustainable expansion. Policy emphasis remained on targeted liquidity support, credit guidance and selective fiscal measures rather than broad rate cuts, aiming to stabilize growth while containing financial risks.

Equities

• The war in Iran, the subsequent surge in energy prices and the fear of stagflation have triggered a correction in global equities. The MSCI World Index was down 6.9% in March. The S&P 500 and NASDAQ were down 7.5% in the month. Energy and defensive sectors were more resilient, while consumer discretionary and energy-intensive industrial sectors were under greater pressure.
• APAC markets also corrected on the back of the Iran conflict, especially considering that many Asian economies are directly exposed to energy supply disruptions through the Strait of Hormuz. MSCI Korea was the underperformer with a 14% decline. This partly reflected the strong gains and heavy retail investor positioning ahead of the war. The rest of the APAC region was down around 7%-9% in the month, with MSCI China being relatively resilient, down 6.9%. Tech development, especially AI, in China could help provide more support to the market, as well as the perception of greater resilience of the Chinese economy during the conflict, given the rise in renewable energy in recent years and Chinese tankers being allowed to go through the Strait of Hormuz by Iranian authorities.

Fixed income

• U.S. Treasury (UST) yields rose on the back of inflation concerns. The 10-year UST yield rose 49bps in the month, and the 2-year yield rose 53bps, as investors are pushing back their expectations for the Federal Reserve to cut rates in 2026. This rise in government bond yields was also seen in Europe and APAC. The futures market for the fed funds rate has priced out any rate cut in 2026, and is instead pricing in a very small chance of higher policy rates this year. This rate hike expectation is more prominent in the euro area and the UK, where OIS markets are pricing in two 25bps hikes by July.
• Along with the correction in risk assets such as equities, corporate credit spreads have been surprisingly resilient as investors seek income through high-quality assets. U.S. IG spreads remain below 100bps, with the rise in energy prices seen as less of a threat to high-quality companies. High yield spreads widened by about 10bps. One can argue that market anxiety over private credits is encouraging investors to allocate more towards public markets with greater liquidity and data transparency.

Other financial assets

• Oil prices were under the spotlight given the war in Iran. Brent crude surged from USD 72 per barrel to a high of USD 118. Oman or Dubai crude benchmarks, which are arguably a better representation of the supply stress in the region, rose even higher. The volatility of the energy market, including LNG, was also significant, driven by military developments in the region and signals from the Trump administration on its strategy in the region. Gold, in contrast, failed to act as a hedge against geopolitical crisis. It fell 15% in the month as investors struggled with higher interest rates and the need for liquidity.
• The U.S. dollar was a safe haven during this conflict on the back of demand for liquidity. The USD index (DXY) rose from 97.6 back to above 100 for the first time since November 2025. The JPY (-2.7% in March) and CHF (-3.7%) also failed to attract safe haven flows.

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