KMD Economic & Market Update – Spring 2026
Keith Wade
Former Chief Economist, Schroders
Adviser to the KMD Investment Committee
Markets think the war is over, time to celebrate?
The outlook for the world economy and markets took a dramatic turn with the US and Israel launching missile strikes on Iran at the end of February. Subsequent attacks on shipping and the destruction of energy infrastructure by both sides pushed the price of brent crude oil up from $72/ barrel to above $100 overnight.
Since then there has been some respite with a ceasefire, but the ongoing closure by Iran and the US blockade of the Straits of Hormuz has kept energy prices elevated with concerns that the supply of some commodities such as jet fuel will dry up altogether. The seizing up of this crucial waterway means the potential for shortages to extend beyond oil to Liquid Natural Gas, fertilizer and even CO2 gas (used in food production).
Inflation, which had been on a downward trajectory before the conflict, has now picked up around the world and is running above 3% in the UK, well above the Bank of England’s 2% target. The increase in price inflation has led to a rise in interest rate expectations as central banks are expected to renew their battle with inflation by tightening policy.
Bonds hit by inflation fears, but equity markets are behaving as if the war is over
However, equity markets appear to be unconcerned by the economic impact of higher energy prices, most notably in the United States where the S&P500 index is now above pre-war levels. When asked about this dissonance most investors argue that political pressures will soon bring the war to an end, the Straits of Hormuz will reopen and oil prices will fall back. Underpinning this is a view that President Trump will not allow oil prices to be elevated for a sustained period of time.
The mid-term elections for the House and Senate in the US are in November and surveys show that the war is unpopular with the public. The high price of gasoline is one factor creating dissatisfaction with the President, another is his breaking of promises not to become involved with foreign wars. The latest surveys suggest there is a good chance of the democrats taking both the House and the Senate in November – an outcome which would certainly constrain the President going forward. To turn this around, the president needs an end to the war and for oil to start flowing again.
The fact that the conflict in the Middle East has moved into a negotiating phase is clearly welcome. The difficulty for investors is knowing how long it will take to agree a deal and bring some normality to global energy supply.
Economists expect stagflation: more inflation and less growth
In the meantime, we would note that oil prices are still elevated at around $100/ barrel, some $30 to $40/ b above pre-war prices. Although some take comfort from the oil futures markets which is expecting crude prices to return to pre-war levels in a year’s time, this does not reflect what households and business have to pay for delivery now. The head of the International Energy Agency has said this is the “biggest shock in history”.
Energy analysts point out that the last cargoes to leave the Middle East before the war began have now been delivered and from now on supply will be severely constrained given the restrictions on transport and damage to production facilities. Cost pressures on inflation will intensify in energy and elsewhere such as agriculture as lack of fertilizer hits crop yields and food prices.
Not surprisingly, both the IMF and OECD have recently downgraded their expectations for growth in the world economy and raised their projections for inflation. Forecasts have moved in a stagflationary direction.
Alongside higher energy costs, two other factors are weighing on growth.
The first, is economic uncertainty which is causing firms and households to put spending plans on hold. Airlines and travel companies are reporting slower bookings as travellers fear the shortage of jet fuel will lead to more flight cancellations. People are ready to spend but will not commit, creating weaker activity today.
The second is the rise in interest rate expectations which has raised borrowing costs and tightened financial conditions. For example, before the war the probability of a rate cut in the US during the summer was greater than 90%, now it is close to zero. Likewise, the Bank of England is not expected to cut rates this year with some warning of a tightening in policy. Bond yields have risen as a consequence, thus increasing the cost of borrowing in the economy.
The rise in longer term interest rates has been particularly marked in the UK where the benchmark 10 year government yield has risen above 5% for the first time since 2008.
One consequence is that homeowners looking to refinance their mortgages will face a steeper increase in monthly costs, exacerbating one of the drags on the economy this year as 1.8 million people roll off their fixed rate deals. For the UK government the problem is particularly acute as higher borrowing costs directly limit the room for manoeuvre under the fiscal rules given the increase in interest payments. Less scope for either tax cuts or higher spending.
Time to celebrate?
There seems little to cheer about right now so what are we missing? In one respect the recent rise in stock markets can be justified as the worst scenarios of total destruction in the war are less likely to be realised. The so called tail risks have fallen as the ceasefire has replaced the fighting. We can discount the worst outcomes.
The market is also discriminating between regions with the US equity market outperforming the rest of the world, particularly Europe where markets are lower than before the war started. As an oil producer and exporter the US is relatively insulated from the energy shock and should be less affected.
It is also true that some areas of the market directly benefit from the war, such as oil and defence companies. And corporate profits have held up very well, with companies in the Artificial intelligence space remaining buoyant as spending on chips and datacentres continues.
It’s also possible that Trump will simply declare victory and walk away from the war prompting a fall in oil prices ahead of the mid-term elections.
In the meantime though as oil prices remain high, economic growth will be weaker going forward and so corporate earnings overall will struggle if only because of the cost of energy and disruption to supply chains.
Overall, a cautious cheer for the ceasefire, but perhaps keep the champagne on ice for now.