More than two months have passed since the U.S. and Israel began their aerial strikes on Iran, and the effects of the conflict have reverberated around the world. The Strait of Hormuz, the key artery through which a fifth of global oil output flows, has mostly remained shut, pushing up oil prices and bringing inflation concerns to the fore.
Although diplomatic efforts have helped achieve a fragile ceasefire, a long-lasting solution is not yet in sight, as a wide gap exists between the negotiating positions of the U.S. and Iran. The main U.S. stock index has been scaling new highs and risk markets in general have remained sanguine.
De-escalation or a protracted conflict: that’s the question as the war enters its third month. While a cessation of hostilities is desirable to secure the economic interests of all parties, diplomatic progress has slowed as hardline factions within the Iranian administration appear to hold sway over negotiations. The probability of a prolonged disruption of the Strait of Hormuz has increased, contributing to a fat-tailed distribution of macro outcomes and requiring a more prudent risk posture for investors.
U.S. economy remains solid
Against this backdrop, the underlying fundamentals of the U.S. economy remain relatively resilient. Structural tailwinds, most notably ongoing investment linked to artificial intelligence, continue to support growth, as reflected in recent GDP data. Earnings revisions for major U.S. equity indices have been robust, reinforcing the fundamental underpinnings of risk asset performance and supporting the household wealth effect.
While labour market data point to low hiring, there is growing evidence that the threshold for maintaining a stable unemployment rate may also be lower than previously assumed. Additionally, manufacturing activity has shown signs of reacceleration. Taken together, these dynamics suggest that the U.S. economy retains some capacity to absorb the energy-driven shock. On the other hand, the increase in energy prices and potential transmission to other components of the basket might keep inflation above target for longer.
In this context, we expect the Federal Reserve to remain on hold in the near term. Even with upcoming leadership changes, the bar for a material shift toward easing appears high given the current balance of risks. As a result, we view U.S. rates as offering limited near-term value.
Policy tightening likely by the ECB and BOE
The outlook in Europe is more nuanced. Growth dynamics remain comparatively weaker, and the region’s higher dependence on imported energy leaves it more exposed to adverse supply shocks. Indeed, consensus growth expectations for 2026 have been revised lower across several Eurozone economies.
At the same time, markets have priced in a meaningful degree of policy tightening by both the European Central Bank and the Bank of England. Both central banks held rates steady in April while maintaining a data-dependent stance. The ECB acknowledged that while current conditions do not yet warrant tightening, the possibility was actively discussed. The BOE outlined a range of macro scenarios, including a more adverse case that could necessitate sizeable policy tightening.
Even so, we believe the scope for central banks to exceed current market expectations is limited. This creates a more asymmetric opportunity set in rates, particularly in the front end and belly of European curves. In a de-escalation scenario, Eurozone rates could rally meaningfully, potentially outperforming their U.S. counterparts.
Volatility likely to remain elevated
In emerging markets, particularly in Latin America, the macro backdrop appears comparatively supportive. Historically, energy shocks have weighed on the region; however, the current episode has elicited a more differentiated response. Large natural resources, relatively low external imbalances, geographic distance from the conflict and credible monetary policy frameworks have underpinned resilience for many countries. At the same time, real yields in markets such as Brazil and Mexico remain elevated, supporting the case for local currency sovereign bonds as one of the most compelling opportunities within global fixed income.
Looking ahead, we expect uncertainty to increase and rates markets to remain sensitive to geopolitical developments. While we continue to believe that second-round inflationary effects are less likely than in prior episodes such as 2022, near-term volatility is likely to remain elevated.
For now, fixed income investors are trading the geopolitical developments mostly as an inflationary shock, which is reflected in higher sovereign bond yields. As active managers with the flexibility to “go anywhere”, we closely follow developments around the world and look for appropriate investment opportunities and adjust our portfolio accordingly.
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