Uncommon truths: Stagflation: scary but unlikely

The breakdown of US/Iran talks leaves us waiting nervously for the next steps. So far during this crisis, financial market reaction has been relatively calm, despite lots of talk about stagflation. The 1970s oil price shock was difficult for investors but we doubt there will be a rerun. 

Financial markets appeared to take comfort from the two-week ceasefire agreed between the US/Israel and Iran and the promise by Iran to open up the Strait of Hormuz (see the one-week returns in Figures 3 and 4). It is to be seen how strongly markets react to the lack of progress in US/Iran talks and the US suggestion it will now blockade the Strait of Hormuz. 

With the VIX index below 20 at the end of last week, and limited asset losses since hostilities started, it could be argued that market participants are relaxed about the duration and consequences of this conflict (the S&P 500 is down less than 1% since 27 February, while the Euro Stoxx 50, FTSE 100 and Nikkei 225 are down only 3.5%, 2.8% and 3.3%, respectively).

Admittedly, the ICE Brent 1st future contract price is still up around 31% (at $95.2 per barrel) and the ICE UK Natural Gas 1st future is up 40%. Further, the market implied path of policy rates suggests a belief that most central banks are now erring on the side of tightening to end-2026, whereas before this conflict many were expected to ease, especially the Fed and the BOE. Hence, the slightly bigger impact on bond markets than on equities (the ICE BofA Global Government Index is down 2.1% since 27 February, versus -1.6% for MSCI World, based on total return indices in US dollars). 

This relative calm seems at odds with media commentary, where the threat of recession and even stagflation is regularly evoked (at least here in the UK). Even central bankers seem to be talking up the potential economic damage (see for example the opinions expressed in the latest Fed Minutes, published on 8 April 2026). 

The mere mention of stagflation is enough to cause unease (in my experience). My definition of stagflation is the coincidence of recession and high inflation, which is a nightmare for central bankers and investors alike. No wonder the stagflation of the 1970s/80s popularised the aptly named Misery Index (inflation rate plus unemployment rate). The US Misery Index was around 7.2% in 2025 Q4 (based on OECD data), whereas it peaked at 21.8% in mid-1980. The UK was at 8.3% in 2025 Q4, versus a December 1975 peak of 31.4%, just as Bohemian Rhapsody was topping the UK charts (the misery was eased by great music!). 

That that period was miserable for investors can be seen in Figure 1. The Yom Kippur War took place in October 1973 and provoked the oil embargo that saw world supply fall by 7% between 1973 and 1975. The subsequent tripling of the oil price in less than six months (based on the WTI spot price) was a boon to commodity investors. The consequent doubling of the US inflation rate (from 5.5% in 1973 Q2 to 12.2% in 1974 Q4) may have contributed to the strength of gold (the price of which had been fixed until the early 1970s). Otherwise, investors struggled to generate positive real returns between September 1973 and the end of 1974. 

Having said that, I am surprised the losses on bonds were not bigger. Perhaps that was because yields had already risen a lot. Having started the 1950s below 2.0%, the US 10-year yield exceeded 7.0% in the early 1970s (it was 6.9% just before the Yom Kippur war). Though it did go above 8.0% during 1974 (reaching 8.11% at the end of August), it was only 7.4% by the end of 1974. A generous carry and limited rise in yields may explain the limited losses. 

The same cannot be said for the S&P 500, with a loss of 42% in real terms between September 1973 and December 1974. Equities struggled with the combination of high inflation and recession (US unemployment rose from 4.8% in 1973 Q3 to 8.9% in 1975 Q2, according to OECD data). Indeed, Figure 1b shows that no sector was spared, not even energy.

Hence, the 1970s episode suggests that investors find it hard to escape the negative effects of stagflation. Were the current conflict to lead to prolonged energy shortages and a steep rise in price (Brent and WTI above $150 for six months or more, say), then the global economy could be pushed in the direction of stagflation, in my opinion. Under such an extreme scenario, I believe the assets best placed to withstand the effects of stagflation are energy commodities, gold and short duration assets such as cash and AAA rated CLOs. Energy commodities speak for themselves, while gold could benefit from the rise in inflation and recession (though the latter benefit would rely on a decline in real treasury yields). Short duration assets would still suffer losses in real terms, in my view, but would largely avoid the negative impact of rising yields. The caveat for gold is that it is already up a lot and has been one of the weaker assets since the outbreak of this conflict.

Luckily, I doubt we will have to deal with anything like the stagflation of the 1970s. First, a 1973/74 style tripling of oil from the pre-war level would suggest spot prices of around $200 for WTI and $220 for Brent. Also, the price gain would have to stick over the coming years (see Figure 2a where the price of WTI barely fell after that 1973/74 surge, even in real terms). I doubt that President Trump would want to go into the US mid-term elections with a $200 WTI price, let alone have his legacy blighted by oil staying at those levels over the next few years.

Even if oil did rise to that extent, I doubt the economic consequences would be as important as in the 1970s. This is largely because the global economy is less reliant on oil than it was in the early 1970s. That energy shock forced the world to become more energy efficient. Figure 2b shows that the oil intensity of global GDP has nearly halved since 1990 (the earliest data I have available) and I reckon it was already much lower in 1990 than in 1970.

In conclusion, it is difficult to predict how the conflict will unfold, given the players involved and the halting of talks between the US and Iran. Higher oil prices over a period of months could reduce global growth and boost inflation, in my opinion. In extremis, an oil price around $200 could rekindle memories of the 1970s, a painful period for investors. However, I don’t think the US wants that, and, even if we get those prices, the world economy is now less reliant on oil, so the impact could be less meaningful. If I am right, non-energy risk assets may rebound over the rest of the year. If I am wrong, energy commodities, short duration assets and, perhaps, gold could outperform. 

All data as of 10 April 2026, unless stated otherwise.

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