Markets are underestimating the impact of escalating conflict in the Middle East, with energy supply risk now emerging as a key driver of inflation and policy expectations.
Recent attacks on critical infrastructure, including a major liquefied natural gas facility in Qatar, have introduced a credible threat to global energy flows.
Equities have softened only marginally and bond yields have adjusted in an orderly way. This suggests that investors continue to assume the conflict will be limited in duration and scope. That assumption is becoming harder to support. The widening nature of the conflict and involvement of additional actors increase the probability of a more sustained disruption.
The implications are clear. Higher energy prices put upward pressure on inflation at a time when central banks were expected to ease policy. That path is now less certain. Rate cut expectations have already been reduced, and further escalation could delay easing or shift policy back towards tightening. This creates a less supportive backdrop for risk assets.
Corporate earnings are another pressure point. While recent performance has been stable, sustained increases in input costs would begin to compress margins. Energy-intensive sectors are most exposed, but the effect would broaden if inflation expectations become embedded.
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