Key Takeaways
- European stock markets fell in the first month of the war but remain broadly neutral year-to-date.
- Oil prices remain far short of historic highs, amid warnings that those may once again be reached.
- Some investors argue that government bond markets have overreacted to the possibility of interest rate increases.
More than a month into the Iran war, and with its course ahead still far from clear, concern is mounting over markets’ ability to accurately factor in the conflict’s global impact.
European Central Bank President Christine Lagarde and BlackRock President Rob Kapito are among key figures warning that investors are being overly optimistic about the path toward normality once fighting ceases.
Some strategists and fund managers say that stock market valuations reflect an element of complacency, assuming a “contained conflict,” while bond markets may have gone too far the other way in pricing in higher interest rates.
“Markets rarely price geopolitical risk well,” says PIMCO global fixed income CIO Andrew Balls. Lauren Hyslop, fund manager at Mattioli Woods, says that “European markets are behaving as if war is a series of passing storms rather than a change in climate.”
Memories of the April 2025 tariff U-turn by President Donald Trump are also creating a complacent mood among investors, experts say.
How Much Further Could Oil Prices Really Rise?
Oil and gas prices have skyrocketed since the conflict began, as shipments through the Strait of Hormuz have ground to a near-standstill. Brent crude oil futures peaked at USD 118 in March, up 63% from their prewar levels as supply concerns reverberated across the global economy. Still, they remain below historic highs, and much higher levels are possible depending on developments in the Persian Gulf.
Morningstar’s director of equity research, Allan Good, says energy markets had behaved reasonably sanguinely so far, given the potential for a near-term resolution.
“When you look at the potential volumes that could be at risk for an extended period—we’re talking about 10% of global oil volumes that may not be able to reach the market—the idea that oil prices are still around $100, I think, reflects the idea that we’re going to get a quick resolution and reopening of The Strait of Hormuz relatively quickly," he says.
Analysts warn that could change if the chokepoint remains closed through April, with Goldman Sachs among those to suggest the global oil benchmark could breach its 2008 record high of USD 147 per barrel.
“If that happens, this stops being a sector rotation story and becomes a broad market stress event,” Saxo Bank investment strategist Ruben Dalfovo says.
No Sign of a Dramatic Selloff in Stocks
The Morningstar Europe Index is now down about 11% since the war began. Still, equities have been quick to latch on to tentative signs of resolution, staging several short-lived recoveries.
“Markets are reacting to the possibility of diplomacy, not proof of it,” says Charu Chanana, Saxo Bank’s chief investment strategist, adding that could spark further sharp swings in either direction as developments evolve.
Mattioli Woods’ Hyslop says that while equity market volatility has picked up, a dramatic capitulation has yet to take place.
“The adjustment still looks tactical rather than a fundamental repricing of geopolitical risk. Valuations continue to lean on a narrative of contained conflict and ultimately resilient earnings. For an investor, that composure is both impressive and unsettling,” she says.
Morningstar chief European markets strategist Michael Field rejects the notion that equity markets are overly complacent, suggesting recent selling has been in line with the duration of the war so far.
Still, he says investors will be closely monitoring the course ahead, and signs of the war becoming protracted. “If this goes on longer, the broader impact is going to hit some industrial stocks harder than is currently priced in,” he says.
In that scenario, Saxo Bank’s Chanana warns stocks would come under far greater pressure, with the economic fallout likely to spill over into sectors such as consumer cyclicals and growth stocks.
“The risk is that the growth hit from the oil shock lingers longer than expected, keeping pressure on confidence and discretionary spending,” he adds.
European Bonds Have Sold Off Sharply on Interest Rate Fears
Government bond markets have repriced drastically since the end of February, as prewar expectations of interest rate cuts by both the European Central Bank and the Bank of England have been turned on their head. The Morningstar Eurozone Core Bond Index is down about 3% since the start of hostilities.
European and UK government bond yields have soared amid sharp repricing of interest rate hikes, which are being reflected in futures markets. Bond prices and yields move in opposite directions.
In the UK, the yield on a two-year gilt has risen a whole percentage point to just shy of 4.5%, while the benchmark 10-year gilt breached 5%, its highest level since the 2008 global financial crisis, last week. The 10-year German bund yield has risen almost half a percentage point to sit just above 3%.
Some investors say that rate markets have gone too far in pricing in hikes this year.
“Similar to the volatility that followed US tariff announcements in April 2025, the rapid repricing of central bank expectations in response to the Middle East conflict has created localized volatility and opportunities to invest against the prevailing narrative,” PIMCO’s Balls says.
“Current market pricing continues to be too focused on the short-term positive inflationary impact of higher energy prices,” says UBS UK economist and macro strategist Dean Turner.
Meanwhile, he says markets are ignoring the potential negative impact on growth in the medium-term which could drive interest rate cuts, as could a de-escalation in the conflict.
Signs of complacency may be found in credit markets, where Balls says only a modest amount of risk has been priced in. “Our emphasis is on adding downside mitigation, given risks have grown more than market pricing may reflect.”
If the current conflict drags on longer than markets expect, fixed-income investors may start to price in a larger hit to economic growth. In this scenario, Insight Investment’s senior portfolio manager Damien Hill says longer-dated government bond yields may fall while upward pressure on shorter-dated bond yields could remain.
For corporate bonds, investors may become less willing to chase higher yields, he says, particularly in riskier areas of the market. As a result, credit spreads, which measure the extra yield that corporate bonds offer over safer government bonds, could widen. “We’ve already seen that in parts of credit which are more correlated to equities and with easier liquidity access,” Hill says.
Where Could Global Markets Go Next?
The course ahead for markets depends heavily on the extent and the duration of the conflict.
Some suggest markets may remain relatively calm as long as apparent peace talks are ongoing, with investors fearful of being caught unprepared should US President Donald Trump announce a sudden U-turn as he did with his 2025 tariffs. On April 9, 2025, the S&P surged 9.5% in a single day as Trump retreated on tariffs in what came to be known as the TACO trade—a tongue-in-cheek acronym meaning “Trump always chickens out.”
“I’m convinced that one day is the only reason markets haven’t gone down more on the war/oil crisis. Everyone who wants to be bearish is terrified of that scenario,” says Ben Carlson, director of institutional asset management at Ritholtz Wealth Management.
Even a swift end to the war would not necessarily mean the end of its disruptive effect on markets. Mattioli Woods’ Hyslop warns the “deeper concern” lies in the second and third order consequences of the war, which are often “harder to model and therefore easy to ignore,” but may already have been set in motion.
Last week, the OECD downgraded its eurozone growth forecast by 0.4 percentage points to 0.8% and raised its inflation outlook to 2.6% as a result of the war. The UK, it said, was likely to be even worse hit, with growth set to fall 0.5 percentage points to 0.7% and inflation hitting 4%.
“European assets price a series of contained crises while the war is forcing a structural rewrite of the continent’s energy system, security posture and public balance sheet. That gap between the surface calm of markets and the depth of the adjustment still to come is where the true risk lies,” Mattioli Woods’ Hyslop says.
