Why is this oil shock different?

This article is an extract from our Q2 2026 Active Fixed Income Outlook.

As we enter the second month of the Middle East conflict, it’s important to remind ourselves of the market’s expectations when the conflict began. Back then, the prevailing mood was that a spike in oil prices to levels over US$100 per barrel, or even higher, was not too concerning. It would be a very different story, however, if oil prices were maintained at elevated levels for longer than two months. Such a scenario would require investors to acknowledge the track record of rising oil/energy prices ending previous cycles when they spike unexpectedly.

 

Despite markets’ historic experience of oil shocks, investors’ lived experience during this time has not been typical. A useful way to think about the future is to compare how markets should have reacted to a major shock with how they actually did. When prices move unexpectedly, it often signals an emerging force that few are yet to understand — and that’s where, in our view, the best opportunities tend to be found.

 

The initial move in risk-free yields was the complete opposite to what most expected, as we tend to see flight-to-quality initially as the safe haven bid overwhelms the transitory

inflation impact from higher oil prices. What was different this time? At the very least, it might suggest that we are still in a post-pandemic environment more susceptible to

inflation shocks. Our rates team has downgraded its view on the insurance value of duration within portfolios, with rising oil prices increasing the likelihood of a more challenging environment of positive (and less helpful) correlation between

spreads and yields.

 

Any fiscal response by governments to higher oil prices will be a crucial factor for this relationship and for markets. The UK government has already floated the possibility of helping people with heating bills, while other governments have either suspended fuel taxes, or are considering similar measures. The repricing of the front-end of yield curves has been significant. While we should always respect what markets are telling us, we think central banks will be reluctant to raise interest rates ahead of a potentially growth-eating oil shock.

 

As the conflict has intensified, risk assets have been forced to acknowledge the increasing uncertainty around the growth and inflation outlook. From being cushioned by rising government bond yields initially, credit spreads have now widened by 10- 20% in March.^[1] This is on top of already wider spreads seen before the conflict. While it already feels a long time ago, we were only just recently grappling with the credit impact of the AI disruption theme, funding the enormous capex requirements of the tech hyperscalers and starting to consider the spillover risks to public markets coming from private credit.

 

The fact that President Trump campaigned on the promise to end American’s cost-of-living concerns and lower interest rates is potentially starting to create an issue for his administration. The most important ‘price’ to Americans has always been the cost of a gallon of gas at the pump – now 40% higher than at the beginning of the year. ^[2]  Meanwhile, expected interest rate cuts have been priced out following hawkish commentary from central banks. This is a potentially challenging political environment for the Republicans and the President ahead of the November mid-terms elections and could be an important factor in the possible duration of the conflict.

 
[1] Source: iBoxx index data as of 31 March 2026

[2] Source: Bloomberg as of 31st March 2026

This article is an extract from our Q2 2026 Active Fixed Income Outlook.