War or peace: Energy, inflation, Europe

The Iran war has repriced geopolitical risk across assets. Given the Strait of Hormuz’s central role in global energy flows, disruption risks have increased the likelihood of higher energy prices and a tougher inflation backdrop. Europe’s higher dependence on imported energy amplifies downside growth risks and relative equity underperformance.

For markets, energy has been the dominant transmission channel. Moves in oil and natural gas prices have fed directly into inflation and rate expectations, while also reshaping risk premia and driving currency performance based on relative energy exposure.

Brent crude prices have traded around 60%–75% above their year end close, while European natural gas prices have averaged nearly double their 2025 levels. This renewed energy-driven inflation impulse has also reshaped the rates outlook, pushing out prospective easing in the US and leading markets to price further tightening in Europe. Europe, in particular, now faces a more classic stagflationary shock.

Navigating uncertainty through scenarios

Markets can often look through geopolitical shocks that are short lived. However, the duration of this war and the breadth of second round effects—across energy, inflation, policy, and corporate margins—remains uncertain. A scenario based framework is therefore useful in distinguishing near term hedging needs from longer term investment opportunities.

We outline two scenarios, 1) Ceasefire and 2) Escalation, alongside structural themes associated with a post‑war normalization, and translate each into portfolio implications.

Scenario 1: Ceasefire holds

De-escalation would be characterized by the reopening of key energy supply routes—most importantly the Strait of Hormuz—the normalization of freight, and a predictable fading of the initial inflation impulse. For markets, what matters most is certainty around the pace of energy normalization. In this scenario, growth takes a short term hit but stabilizes as confidence recovers. Against this backdrop, central banks are more likely to re-emphasize growth risks and disinflation, allowing markets to reprice a more accommodative policy path.

Even under a ceasefire, a residual geopolitical risk premium is likely to persist in energy markets, with Brent crude expected to average above $80 for the rest of the year. Structural capex themes—including grid investment, LNG infrastructure, storage, and renewables, with Industrials as key suppliers—remain well supported. Separately, technology investment should stay resilient as companies and governments continue to prioritize security and productivity.

Improving risk sentiment would typically support a rotation back toward cyclicals and quality growth. Emerging market equities may benefit as energy import pressures ease and global financial conditions stabilize, although the US dollar bears watching. Within developed markets, US small and mid cap equities could recover on a more dovish rates outlook and a tightening in credit spreads.

A core tilt to the US remains defensible given its sector composition—technology, defense, and a meaningful energy complex. Select Emerging Markets, particularly commodity exporters in Latin America, stand to benefit from a normalization in risk sentiment alongside ongoing commodity related capex.

In a de-escalation regime, duration can be added selectively as inflation fears fade and rate cut expectations re enter the conversation. The US dollar typically softens as risk appetite improves, while oil importing currencies, such as GBP, may stabilize.

Europe lens

For European investors, de-escalation reduces the immediate stagflation risk and may offer some near term relief. It does not, however, reverse the strategic case for energy independence, renewables, and defense rearmament, which remain structural allocation priorities.

Shipping and insurance costs through the Gulf, OPEC+ communication, inflation breakevens, and European PMIs will be key indicators of market sentiment.

Scenario 2: Escalation

Escalation implies a longer-duration disruption to shipping and energy supply, and a sustained rise in risk premia, with oil prices rising possibly as high as $150 per barrel. The inflation impact becomes more persistent, increasing the probability of demand destruction and negative earnings hit. Central banks face a pull between inflation control and recession risk.

A significant rise in the real price of oil tends to coincide with US recessions as real incomes get squeezed and consumers pull back (Figure 1). Such an outcome in 2026 would require a sustained throttle on energy supplies well into late Spring.

A risk‑off regime typically favors defensives—Utilities, Health Care, and Consumer Staples—and businesses with resilient cash flows. Energy producers and selected oil‑services names can outperform on higher prices, while defense and cybersecurity may attract incremental spending. By contrast, energy‑intensive industries (e.g., chemicals and food producers) and highly levered cyclicals face the greatest downside from margin compression and tighter financial conditions.

The US is relatively more resilient given its domestic energy production and index composition. Energy‑importing regions most exposed to an oil‑driven inflation shock—Europe, Japan, and parts of Asia—remain underweight candidates.

Haven demand can support government bonds during episodes of acute stress. However, oil‑driven inflation can limit the downside in yields. In credit, spreads typically widen in a protracted shock. In an escalation regime, portfolio construction should emphasize resilience through inflation‑protected bonds (e.g., TIPS) and high‑quality liquidity.

Elevated geopolitical risk tends to support the US dollar alongside traditional havens (CHF, NOK), while the euro can come under pressure as Europe’s terms of trade deteriorate. Gold typically benefits from a combination of risk aversion and inflation‑hedging demand, although it has not yet responded meaningfully in this conflict. Broad commodities can still provide a partial hedge.

Europe lens

The episode underscores the importance of diversifying regional exposures, stress testing energy sensitivities, and maintaining relatively liquid hedges such as commodities and gold. In response, many institutional allocators have increased US exposure. Within Europe, tilts have favored sectors with pricing power or direct beneficiaries of both the shock and the policy response—namely Energy, Defense, Utilities, and Infrastructure.

Diversification has been the key differentiator: portfolios with meaningful non European exposure, inflation linked assets, and commodity hedges have generally weathered the shock better. For Europe, the conflict has exposed key vulnerabilities—energy dependence and insufficient defense capacity—while accelerating investment programs aimed at addressing both.

The bottom line

Energy is the dominant transmission channel from geopolitics to markets. Whether through de escalation or escalation, Europe remains structurally exposed, arguing for diversified portfolios, selective inflation protection, and positioning that captures both downside resilience and longer term adjustment themes. 

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