Three scenarios: the bull, the bear and the base
The key question for investors is: what might happen next?
In a bull (best case) scenario, the Middle East conflict would be resolved relatively quickly. Energy prices would retreat towards pre-escalation levels, easing pressure on inflation.
Such an outcome would likely support a more equity market friendly policy environment in the US. Against a backdrop of fading geopolitical uncertainty and tariff effects, central banks would have greater confidence to continue easing monetary policy. Before the conflict, market participants were pricing in two US interest rate cuts in 2026. A swift resolution could bring those expectations back into focus.
A bear (worst case) scenario would see the conflict escalate and persist. A severe outcome could involve direct US military intervention and attempts to forcibly reopen the Strait of Hormuz.
Under these conditions, oil prices could rise sharply and remain elevated, feeding sustained inflation. To date, inflationary pressures have been confined to energy-related components. This has lifted headline inflation, while the impact on core inflation — which strips out energy and food prices — has remained muted.
In the US, continued energy disruption would increase the risk of broader price pressures as companies pass higher input costs on to consumers. In response, the US Federal Reserve (Fed) could raise interest rates, impacting economic growth potential. Our analysis indicates that the global economy has sufficient momentum to withstand an end to US interest rate cuts, but a shift to hikes would have more significant implications.
Higher energy costs would also compress corporate margins and erode real wage growth, weighing on earnings.
The global economy as a whole has become less reliant on energy markets, but this trend has not been felt evenly across the world in recent weeks. European and Northeast Asian economies are particularly exposed to sustained energy disruption, while the US and other oil exporting countries are less vulnerable. A prolonged conflict would therefore be felt differently across regions.
Our base case sits between these extremes. We believe the economic and earnings momentum as the conflict began was strong enough for equity markets to absorb the economic consequences. Energy disruptions are likely to push headline inflation higher in the near term, but we expect this to resemble a one-off price shock, not a sustained inflationary spiral.
Core inflation should see more limited pass-through given relatively subdued labour markets and muted wage pressures. This should temper central bank responses, especially in the US, where the Fed’s dual mandate of price stability and stable employment allows greater flexibility.
Slower growth, but still growth
The International Monetary Fund estimates that global GDP growth in 2026 could fall from 3.4% to 3.1% under a short-lived conflict scenario, declining to 2.5% if tensions persist, and falling to 2% in a severe outcome.
We agree that growth is likely to be slower than it would have been without the conflict, but it should stay in positive territory. Against this backdrop, we remain overweight equities in our portfolios and funds while maintaining broad diversification across asset classes.
