From Laura Cooper, Managing Director, Head of Macro Credit and Global Investment Strategist, Nuveen
Markets are facing a geopolitical shock – but the investor playbook isn’t working. Government bonds are not behaving like reliable safe havens as inflation concerns tied to higher oil prices outweigh growth fears, disrupting the traditional risk-off template.
While the duration of the conflict remains crucial, markets have already moved to scale back rate cut expectations – a repricing that looks increasingly premature. Central banks are constrained, and monetary policy can curb demand, not offset a supply-side shock. In fact, tighter policy risks exacerbating the macro drag.
It leaves investors seeking safety more selectively, with traditional hedges deserving fresh scrutiny.
Spillover to the global economy
A sustained rise in oil prices, reinforced by transport disruptions, carries meaningful implications for global inflation paths. The key question for policymakers is whether higher energy costs de-anchor inflation expectations or are ultimately viewed as a transitory supply shock.
Rates markets have already moved: pricing for a full Fed cut has shifted toward September from July, Bank of England easing bets have been pared back sharply, and ECB expectations have pivoted from a possible 2026 cut to an extended policy pause.
But central banks are entering this phase with less policy flexibility, fiscal dominance risks, and greater uncertainty around the growth-inflation trade-off. That backdrop argues for a delay in policy moves rather than a structural shift in rate paths.
Fed can’t cool a supply-side inflation shock
Even a worst-case closure of the Strait of Hormuz – through which roughly 20% of global oil supply flows – is estimated by the Federal Reserve Bank of Dallas to have only modest and largely transitory effects on core inflation and price expectations, with transmission running primarily through gasoline.
Higher energy prices also act as a tax on consumers. With limited buffer for US households already, the drag on real incomes would weigh on growth, and over time, support a more accommodative stance rather than a tightening one.
Importantly, monetary tightening is designed to curb demand, not resolve supply shocks. Central banks can reduce demand, not produce more oil.
ECB monitoring “very carefully” while BoE delayed not derailed
The risks are more acute in Europe, where energy sensitivity is higher and LNG disruptions have already driven a sharp rise in gas prices. However, policymakers have signalled that it is too early to conclude that the shock will materially alter the growth or inflation outlook.
Any renewed inflation impulse also raises the likelihood of government cost-containment measures, which would cap upside price pressures, but add further fiscal drag.
For the UK, the combination of higher inflation and weaker growth does not justify a hawkish shift. Labour market slack is building, wage pressures are easing, and the ongoing fiscal drag point to a near-term pause rather than a material repricing of the Bank of England’s easing cycle.
From an investment perspective
The geopolitical shock is inflationary at the margin. And the recent flight to safety in Treasuries has already begun to fade, reinforcing our view that fiscal dynamics now matter more than incremental monetary policy shifts. The fiscal impulse remains large, inflation risks are asymmetric, and political pressure on the Federal Reserve persists. Together, these forces challenge Treasuries’ safe haven status.
The dollar may find near-term support as investors seek liquidity. But the structural drivers of dollar weakness remain intact : narrowing growth differentials, rising fiscal concerns, and a gradual diversification away from US assets.
Five Takeaways to Shape Markets
- Policy pauses, not pivots. Markets have moved quickly to pare back rate cut bets, but risks still skew toward cuts coming later in the year from the Fed and BoE rather than a structural shift in policy.
- Long-end yields remain driven by fiscal dynamics. Geopolitical-led rates rallies are likely to fade as fiscal concerns re-emerge – favouring up-in-quality credit and income generating assets over long-end government bonds.
- Dollar strength is tactical, not structural. Haven flow may support the currency near term, but the longer-term trend remains towards gradual diversification.
- Emerging markets face asymmetric risk. Higher energy costs and dollar strength create familiar pressure points, but dispersion is wide and EM fundamentals remain supported, creating selective opportunities.
- Volatility will reinforce structural dispersion. Selective opportunities continue to emerge – while traditional safe havens face renewed challenge.
While the net effect of the shock remains unclear, the implication is not a rethink of central bank policy paths, but a reassessment of what constitutes true portfolio protection.
