The global monetary landscape has shifted hard due to the Iran conflict’s impact on oil, LNG, and other commodity prices. Coordinated easing is no longer in the cards.
The Fed has effectively gone from cuts to a wait-and-see mode. Despite a 0.25% cut officially pencilled in by year’s end, the dot plot and market pricing now reflect a neutral, if not hawkish, bent. That is not a surprise, even as the US is far more energy-independent than Europe and Asia. US gasoline prices alone are up about 33% on average since the war broke out.
As Europe and Japan are far more energy-imports exposed, it is no surprise the BoE, ECB, and BoJ have turned far more hawkish. Oil and gas prices have risen sharply enough to push headline inflation back up, and policymakers are clearly worried about the first-round energy impact and, no doubt, even more about second-round effects: wages, pricing behaviour, and inflation expectations. ECB President Christine Lagarde said the ECB could respond to a moderate but persistent overshoot in inflation. In the UK, markets have swung from expecting cuts to pricing as many as two hikes by July.
There is also a credibility argument for hiking. After the 2022 inflation shock, central banks are more sensitive to the risk of appearing complacent if businesses pass through higher energy costs quickly. We are not hearing from central bankers that the same inflation is ‘transitory’ or ‘temporary’ this time around. The ‘look through the shock’ approach is much harder politically and institutionally now.
But we also appreciate that oil supply shocks are initially a tax on growth. An inflation spike spurs policymakers to hike rates, and higher energy costs dovetail with higher rates, often inducing a recession, which then prompts policymakers to turn around and cut. Moreover, current policy rates are already much higher than in 2022, fiscal stimulus is smaller, and growth across the eurozone, the UK, and the US is weaker.
So, market expectations may shift. Policymakers might tolerate some headline inflation if they think – but do not say – the shock really is temporary and that growth damage is larger than the inflation risk.
Still-challenging valuations in the US
For global equities, broad sell-offs that cause share prices to diverge from business fundamentals allow us to upgrade portfolios, even as we consider FX volatility and terms-of-trade hits. Among our best investments four years ago were European utilities, which sold off amid market panic over the suspension of Russian gas imports, as did many industrials.
While gas and oil concerns are resurfacing now, we do not think the situation is identical. Unlike 2022, current risks to gas supply volumes do not appear as ominous, thanks to improved European energy infrastructure and diversified supply sources. This is not just from the US; Italy can also get incrementally more natural gas via pipelines from Azerbaijan and Libya. Spain’s Iberdrola is well-positioned after great rains this season, but it is hedged, so it is making good money, but not a massive windfall if spot prices come down. And they probably will not anytime soon. That is not bad for European utilities, as they benefit from marginal power pricing systems, just as they did in 2022.
Government interventions are again possible and even likely if high gas prices persist, capping wholesale power prices and supporting retail and vulnerable industrial customers with energy price caps and subsidies.
With the interesting exception of China, global stocks have declined more than US equities since the war with Iran began. This reflects not just the US’s greater energy independence versus Europe and Asia, but also that much of EM, Japan, and Europe had banner returns in 2025. Year-to-date and over the past 12 months, however, they remain ahead of US returns.
Supply dynamics are not easy to assess. But we do know China has built considerable strategic petroleum reserves, has plenty of domestic coal, benefits from its renewables buildout, and has natural gas pipelines from Russia and Central Asia – not to mention its nuclear power fleet. Hence, China’s more modest equity market decline this far into the conflict.
As for Europe, perspective is helpful. Europe has materially reduced its dependence on Russian gas since 2022, continued its renewables buildout, and shifted to US-sourced LNG imports. Despite the energy shock and sanctions on Russia, over the last four years, the EURO STOXX 50 Index has returned an annualised 14.9% in USD terms, outperforming the S&P 500’s 12%.
This oil and LNG shock will fade over time, with supply and demand returning to balance once the dust settles. In the meantime, Japan and South Korea, both of which have long prepared for such a bottleneck in the Strait of Hormuz, also have some of the world’s most extensive strategic energy stockpiles. Brazil, Mexico, and Argentina will benefit from oil and agricultural exports amid improved terms of trade.
The experience over the last four years speaks to the benefits of continued diversification, especially given the still-challenging valuations in the US relative to global equities. Once the war is over, investment flows should return to the GCC, reducing demand for US assets and the USD.
By Lei Wang, portfolio manager at Thornburg Investment Management
