Skyrocketing oil prices and warning signs in the bond market are putting investors worldwide on alert. Will stagflation now follow?
• Worrying market pattern in view
• The Iran conflict is driving up energy costs massively and fueling concerns about stagflation
• Market experts on the likelihood of a stock market collapse
Warning signs: Is there a threat of stagflation?
The USFinancial markets are currently exhibiting a worrying pattern that experts are calling “bear flatteners.” The yields on short-term government bonds rise significantly faster than those on long-term securities, as Dow Jones Newswires explains. In particular, the yield on two-year US bonds has recently risen significantly and even exceeded the Federal Reserve’s key interest rate (3.5 percent to 3.75 percent). The main driver of this development is the drastic increase in oil prices as a result of the Iran conflict.
This energy shock is fueling investor fears of stagflation – a combination of stagnant growth and high inflation. With the Fed having little room to cut interest rates due to inflation risks, traders are now even pricing in the possibility of further rate hikes in 2026, putting pressure on bond and stock prices alike.
Parallels to 2008: Historical warning signals
The simultaneous occurrence of rapidly rising oil prices, an inverted yield curve and yields above the Fed’s key interest rate also brings back dark memories for market participants: this constellation was last observed in the spring of 2008, shortly before the collapse of Lehman Brothers.
“The current situation reminds me of 2007-2008, when there were actually cracks in the financial system,” said economist Derek Tang of Monetary Policy Analytics in Washington, according to Dow Jones Newswires. The bad news now is that “we are headed for an energy price shock and the Fed’s hands are tied due to inflation risks, making rate cuts more difficult.” All of this is taking place against the background of an increasing probability of recession in the USA, which is “not good” for risky investments. “That’s why investors are currently extremely unsettled.”
However, there are also important differences to the financial crisis of 2008: today’s banking system is considered more resilient and the US economy is less dependent on the price of oil than it was back then. While the real estate market was the trigger in 2008, today the focus is on geopolitical risks and tensions in the private credit sector.
Experts comment on the risk of stagflation
Veteran market strategist Ed Yardeni also warned in a recently published analysis of a return to 1970s-style stagflation and raised the probability of a corresponding stock market crash this year from 20 percent to 35 percent, Fortune reports. The trigger for this skepticism is primarily the Iran conflict and the associated blockade of the Strait of Hormuz, which has driven up the price of oil.
Yardeni sees parallels to the historic oil crisis, as the threat of Iranian drone attacks is putting massive strain on global energy and fertilizer supply chains despite planned US escorts. “The US economy and the stock market are currently caught between Iran and a difficult situation,” said Yardeni. “The same goes for the Fed. If the oil price shock continues, the Fed’s dual mandate would be stuck between the rising risk of higher inflation and rising unemployment.
Despite these acute risks, Yardeni is sticking to a fundamentally optimistic base scenario and still puts the chance of a continuation of the “Golden Twenties” at 60 percent. He argues that the U.S. economy is now significantly more resilient to energy price shocks than in the past because of its own role as the world’s largest oil producer.
Other analysts also warn of the long-term collateral damage of a protracted war, as investing.com reports. Hyun Song Shin from the Bank for International Settlements emphasizes the danger of financial chain reactions: “If the conflict drags on, financial amplification effects could worsen the macroeconomic effects.” He also warns of the impact on markets, as “a sharp rise in interest rates could put pressure on asset valuations.”
Some observers also see a dangerous discrepancy between market expectations and the reality on the ground. Frederic Schneider of the Middle East Council on Global Affairs warns: “In my opinion, the markets underestimate the risk of a protracted war,” and outlines the “worst case scenario” of an “economic collapse combined with interest rate hikes to curb inflation.” The fact that this concern is already influencing monetary policy is shown by the Australian central bank, which explicitly justifies its interest rate steps with the conflict, as this has led to “significant increases in fuel prices”, which means there is a “significant risk that inflation will remain above the target value for longer than previously expected.”
Even if the fighting ends soon, there is no guarantee of immediate relief as, according to the Chicago Council on Global Affairs, “ongoing geopolitical uncertainties and the inevitable delays in restarting abandoned oil wells could keep oil prices high for months.”
The combination of geopolitical tensions, rising energy prices and a pressured bond market now presents investors with a historic challenge. Whether the system will survive the current rifts without a deeper collapse will depend on further developments in the Middle East.
Evelyn Schmal, editorial team at finanzen.net
