Taking stock of the energy shock: 9 macro and market insights

The spike in energy prices since the start of the Middle East war has of course been driven by closure of the Strait of Hormuz, through which 20% of the world’s oil and natural gas generally flows. As of this writing, a multi-point peace plan and a one-month ceasefire were reportedly being discussed, and that would unequivocally be good news for the global economy and the financial markets. But even if the strait is reopened, damage to production facilities and infrastructure, such as LNG facilities in Qatar, has raised the specter of higher energy prices for longer.

Against that uncertain backdrop, I want to offer some perspectives on the impact of the conflict to date — with the caveat that these views and estimates are subject to change as circumstances evolve:

1. Economic growth — For context, every $10 increase in energy prices costs the US economy an estimated 0.15% of GDP and the global economy an estimated 0.3% of GDP (the US is lower because it’s a net exporter of energy). Coming into the crisis, US energy expenditures were at their lowest level as a share of GDP in more than 50 years, and global expenditures were trending down and not far off their half-century lows. This, coupled with accommodative fiscal and monetary policies entering the year, gives some breathing room for 2026 growth assumptions.
   
   However, in the US, higher energy prices have already nearly offset the economic boost expected from tax refunds this year, and if prices rise further, that benefit will be wiped out completely. Europe and Asia, as net energy importers, have been hit harder but are expected to use fiscal policy to counteract some of the damage. In addition, while the growth impact thus far appears manageable, the risk of nonlinear shifts could rise if energy prices continue to surge — historically, we’ve seen that a two-percentage point increase in energy expenditures in one stroke can lead to a recession. For the US, that could come into play if we see oil prices north of $130.
2. Inflation — Rising energy prices have a greater impact on inflation, with every $10 increase in prices adding about 0.3% to CPI in the US and a touch less elsewhere. I expect a 1% increase in CPI in coming months, with gasoline hitting $4.00+ at the pump. Current energy futures imply that prices will peak in the second quarter and then start to moderate but remain elevated at year end.
   
   Agriculture prices also bear watching, given rising fertilizer costs (roughly a quarter of global fertilizer production passes through the Strait of Hormuz) and energy costs. A further increase in these costs would make the price shock larger and more detrimental for consumers and the economy.
3. Interest rate policy — Given that inflation was already at target or higher in much of the developed world when the crisis began, shifts in central bank reaction functions have been notable, with markets now pricing in rate hikes for this year (e.g., Europe, the UK, Canada). In the Federal Reserve’s March meeting, Fed Chair Powell stressed a “wait and see” outlook but suggested that inflation readings will take precedence over growth in the near term.
4. Other policy pivots — To alleviate some of the near-term pain of higher energy prices, governments have thus far released about 400 million barrels of oil through strategic petroleum reserves. In addition, the US has offered sanctions relief on Russian and Iranian oil, and countries like India have provided subsidies to help delay the impact of energy price passthroughs. We should expect to see more price caps, subsidies, and gas-tax holidays (like those emerging in some US states, including Georgia).
5. Emerging markets — Emerging markets entered the year with lower inflation profiles, especially China. This leaves some of them with greater ability to absorb the increase in inflation. Differentiation is key, with commodity-exporting countries holding up far better than importers. Asia as a bloc (including Japan) has been hardest hit by the conflict, given its heavy reliance on energy imports, especially from the Middle East.
6. Corporate profits — Profits for the energy sector will be marked higher, while companies that use energy and fertilizer, as well as other downstream inputs, will face markdowns in coming quarters. Expect profit margins for consumer and industrial companies to face some pressure.
7. Equity market impact — An environment of rising inflation and slowing growth would shift the backdrop for the equity market from a disinflationary regime to a stagflationary outcome, implying that equity multiples should compress over time if the geopolitical premium lingers in the market.
   
   For some historical context, past energy spikes have resulted in a median market drawdown of roughly 5% for the S&P 500, while the damage has been about twice as great for Europe and Japan.¹ Thus far in the current crisis, some markets, including the US and Europe, have reached these historical drawdown levels before regaining some ground. For its part, China has held up better than in prior spikes, given its reduced vulnerability to oil prices and the fact that some Iranian tankers have been able to continue delivery to the country. Looking ahead, I think changes China has made (e.g., greater reliance on renewables) could help it end up a relative winner with the ability to continue strengthening its already strong hand in the global manufacturing landscape.
   
   That said, history has shown there’s potential for more extreme developments during an energy crisis. For example, during the Arab oil embargo (1973 – 1974), oil prices more than doubled. And yet, that event removed only about 7% of oil supply from the market at the time, while the current shock is affecting 20%. Until the strait reopens, the risk of further damage to energy infrastructure leaves the possibility of worst-case scenarios on the table.
   
   In terms of equity market (S&P 500) performance by industry group, energy has historically stood tall in these crises, with profits growing as noted above, while consumer durables, autos, retail, and banks have underperformed. When the war eases, these groups should find relief, though the earnings hit will have to be absorbed. From a technology sector standpoint, it’s worth noting that Asian reliance on Middle East oil imports could spill into higher prices for chips needed by the US.
8. Global defense spending — Last year, the geopolitical environment was marked by the reorientation of trade flows, as tariffs took center stage. This year, military strength displays by the US have contributed to record-high geopolitical uncertainty (and a feeling of malaise in the US population, who care relatively less about such matters when facing pocketbook issues like rising energy costs). As a result, defense spending globally is getting another boost, on top of those from prior shocks in this business cycle, including the Ukraine war. In particular, the Pentagon has requested an additional $200 billion through Congress to fund operations in the Middle East.
9. Energy security — The war will also bring more attention to the long-term theme of energy security. For example, Asia will likely look for ways to diversify away from the Middle East, much like Europe did from Russia after the invasion of Ukraine. In Japan, nuclear power, green energy, and other alternatives to oil could all get a lift.

Final thoughts

At the onset of the crisis, my observation was that the market was overly complacent about the risks around the war. Now, with equity market drawdowns having moved us closer to those seen during prior crises, I think more of the risks facing the economy and markets have been captured. Still, market multiples remain elevated relative to the past, in an environment where the size of the oil shock is larger than historical precedents.

From a US domestic standpoint, the president has a lot to lose with midterm elections looming. But even if that helps bring about an end to the fighting and provides some relief to markets, higher energy prices than before the conflict imply higher input costs for companies. Investors will reward companies that are able to maintain pricing power and preserve profit margins. Meanwhile, central banks will stay vigilant in their efforts to anchor inflation expectations in the face of a negative supply shock, leaving a less favorable equity and bond market backdrop than before the war.

¹Sources: Bloomberg, MSCI, Datastream, UBS. Based on seven historical episodes: Iranian Revolution; Gulf War; OPEC Supply Constraints; Venezuelan Oil Strike; Outages in Venezuela, Iraq and Nigeria; Arab Spring; and Russian invasion of Ukraine. For illustrative purposes only.