While the economic outlook was still fairly positive at the start of the year, the Iran conflict has changed the situation considerably – especially for Europe. The sharp rise in oil prices is slowing the global economy while also increasing inflationary pressure. How severe the impact will ultimately be depends above all on how long the Strait of Hormuz remains closed.

The bond markets have already reacted to the prospect of higher inflation and tighter monetary policy. By contrast, the equity markets appear surprisingly calm. They are benefiting from the fact that the conflict has so far had little impact on the business and profits of many companies. In addition, there is still hope that energy prices will normalise again in the foreseeable future.

One shock after another

Even if the Iran conflict eventually comes to an end, calm is not likely to be restored automatically. Since the pandemic, the global economy has been repeatedly buffeted by new shocks: lockdowns, Russia’s attack on Ukraine, trade tariffs, and now the Iran conflict. There are many indications that the global economy will continue to be affected by such shocks in the coming years.

The world has become more unsettled as the West’s leadership role has weakened and new centres of power have emerged. While efficiency used to be the main priority in the global economy, security and geopolitical interests are now at the forefront. Trading, capital flows and technology have long since become political instruments. Control over strategically important trade routes is an effective way to exert pressure on the major powers. It therefore cannot be ruled out that Iran will continue to use the Strait of Hormuz as to gain leverage in the future.

The consequences of such shocks, which economists refer to as negative supply shocks, are well known: lower economic growth, higher inflation, and more volatility in portfolios. This is particularly evident in Europe. The Eurozone has been hit by the crises of recent years harder than other advanced economies. Its economic performance has therefore been correspondingly weak.

Shocks lead to more inflation

We are already observing higher inflation in the USA, where – unlike in Europe – price pressures have not eased since the pandemic. The US inflation rate has been above the central bank’s inflation target for more than five years. It is still too early to tell whether a new inflation regime has emerged. Nevertheless, it seems quite possible that inflation in many industrialised countries could settle at around 3 per cent rather than 2 per cent in the future. This is not only supported by geopolitical supply shocks, but also by structural developments such as ageing populations and the realignment of global supply chains. Switzerland is likely to remain an exception in this regard, not least because the strong Swiss franc should help keep inflation below 2 per cent.

Moderately higher inflation would generally be manageable for the equity markets. A sharp rise in inflation would be problematic, as this would require more restrictive monetary policy. However, higher inflation would also mean a stronger positive correlation between shares and bonds, which would reduce diversification and make portfolios more volatile. Bonds therefore remain relevant. They continue to play an important role in many portfolios, helping to reduce risk. At the same time, investors are likely to look increasingly to other asset classes that offer additional diversification. Gold in particular could benefit from this.

What matters now

At the beginning of the year, investors had legitimate hopes of a good stock market year. This is still a possibility, even if the outlook has recently become more uncertain. Especially during such phases, it is crucial to remain invested, diversify risks broadly and not lose sight of the long term, even in midst of turbulence. This is because, despite crises and setbacks, the global economy has always found ways to continue growing.

Roger Wohlwend, Chief Economist at the LLB Group

Roger Wohlwend studied electrical engineering at ETH Zurich. After his studies, he worked in Swiss industry for two years as a development engineer before moving to asset management at LLB in 2007. After several years in investment fund management, he took on the position of Chief Economist in 2024.