Markets brace for prolonged volatility as Middle East tensions reshape global investment outlook

Geopolitical tensions in the Middle East are rippling across global markets, forcing investors to rethink traditional playbooks as inflation risks climb and volatility becomes more entrenched.

A new quarterly report from FTSE Russell highlights how the conflict has disrupted what had been a relatively stable macroeconomic backdrop, with energy markets acting as the primary transmission channel into broader financial conditions.

Oil supply concerns sit at the center of the disruption. While Iran itself is not a dominant exporter, the Strait of Hormuz remains a critical artery for global energy flows, carrying roughly a quarter of all seaborne oil.

Any threat to that passage has amplified price pressures, particularly for energy-importing economies across Asia and those pressures are already feeding into inflation expectations.

Since late February, short-term inflation swaps in both the US and Europe have climbed notably, prompting markets to rethink the path of monetary policy. Rate cuts that had been expected later in 2026 have largely been priced out, with some regions now bracing for potential tightening instead.

Stagflation risk

The knock-on effects are raising the specter of stagflation. Higher energy costs are pushing prices upward while supply disruptions threaten productivity and growth. In some economies, energy shortages have already led to reduced working hours in certain industries, underscoring the broader economic strain.

Volatility signals suggest this may not be a short-lived shock with equity market turbulence building gradually rather than spiking, pointing to a potentially extended period of instability. Options markets indicate growing demand for downside protection, especially as March progressed and investor sentiment deteriorated.

Commodities have emerged as the clearest winners in the new environment with a sharp surge in oil prices, with one-month gains ranking among the largest on record. At the same time, divergence within the asset class has widened, with industrial and precious metals lagging even as energy prices soar; an unusual pattern that reinforces stagflation concerns.

Havens or haven nots?

Traditional safe havens have delivered mixed results. Government bonds and gold both declined during the March selloff, defying their typical defensive roles, while the US dollar stood out as the primary refuge, supported by safe haven flows and the country’s position as a net energy exporter.

Equity markets are also undergoing a shift in leadership and while energy stocks have posted gains, broader defensive sectors have not consistently delivered protection. Instead, investors have gravitated toward large-cap technology names and infrastructure-related assets, reflecting a preference for companies with strong balance sheets and resilient revenue streams.

Fixed income markets

Fixed income markets tell a similarly complex story. Yields climbed sharply in March as inflation fears outweighed the usual flight-to-safety demand for bonds. While some late-month buying emerged, elevated yields suggest investors are still demanding compensation for persistent inflation risks.

Looking ahead, markets appear caught between two competing forces: near-term geopolitical uncertainty and longer-term structural themes such as artificial intelligence and emerging market growth. While de-escalation could refocus attention on those secular drivers, the report suggests that risk premiums, particularly in energy, may linger even if tensions ease.

For advisors and investors, diversification strategies may need recalibration as old assumptions about safe havens and defensive positioning are put to the test in a more volatile, inflation-sensitive world.