Why oil, and why now?
The fate of the global economy is currently being decided along a waterway just 34 kilometers wide. What began as a targeted military operation against Iranian targets has, within a few weeks, caused a deeper energy crisis than Russia’s invasion of Ukraine.
With the de facto closure of the Strait of Hormuz, Iran has severed the energy market’s most vital artery. Ship traffic through the strait plummeted by over 90%. The bottleneck has become a dead end. The problem is no longer a shortage of crude oil, but the impossibility of transporting it: Saudi Arabia halted production at its largest refinery as a precaution. OPEC+ did announce a production increase for April – but new barrels are of little use if they cannot leave the Gulf.
The price reaction was accordingly sharp: Brent rose from around $66 per barrel – the 2025 annual average – to over $112 at times, before stabilizing in the $100 range. Wall Street analysts’ base-case scenarios assume an average price of approximately $100 for the coming months. But the risks are asymmetrically distributed: J.P. Morgan estimates that reassuring headlines could push the price down by perhaps $10 – but a ramp-up of production cutbacks in the Gulf would drive it up by $30.
For a multi-asset portfolio manager, the question arises: Can one afford to ignore oil price dynamics?
Oil and inflation: the transmission channel
Oil affects portfolios most directly through inflation. On this point, the forecasts from major investment firms are surprisingly consistent: A sustained 10% increase in the price of oil raises U.S. headline inflation by about 20–35 basis points, while core inflation rises by only 3–4 basis points. The effect on headline inflation lasts about three months and then fades – provided the price spike remains temporary. For the eurozone, the sensitivity is even more pronounced: Morgan Stanley estimates that a $10 per barrel increase raises HICP inflation by about 40 basis points; if prices remain sustainably elevated at $80 per barrel, the increase would be as high as 60 basis points – well above the ECB’s 2% target.
Goldman Sachs has raised its forecast for U.S. headline PCE inflation at the end of 2026 by 0.8 percentage points to 2.9%. The core rate stands at 2.4%, which is 0.2 percentage points higher than before the conflict. Without tariffs and the oil shock, the core rate would be around 2.3% – close to the Fed’s target.
This highlights a tension that we already outlined last September: While oil is driving prices up in the short term, artificial intelligence acts as a structural deflationary force. We view AI as a “perpetual machine” for price suppression – a highly efficient factor that central bank models have so far barely captured. This thesis has not changed. The oil price shock is the strongest cyclical counterforce to this structural trend. It temporarily overshadows the AI-driven disinflation dividend without eliminating it. The task for portfolio managers is now a balancing act: They must separate the cyclical wave of inflation driven by oil from the structural deflationary force of technology – and radically align their asset allocation with this divergence.
Oil and central banks: the return of interest rate hikes
Oil price shocks present central banks with a dangerous dilemma: rising prices are coupled with slowing growth. While the ECB was still signaling interest rate cuts as recently as January, the threat of inflation exceeding 3% is now forcing a radical reversal. Major institutions are already anticipating new interest rate hikes – a scenario that no one had on their radar just weeks ago.
The U.S. is more resilient thanks to shale oil, but at a certain point, oil paradoxically has a “dovish” effect here: Prices destroy demand so effectively that they trigger a recession and tend to force the Fed to cut rates.
The implication for duration: Historically, yields on 10-year U.S. Treasuries rise by an average of 60 basis points following oil shocks, as energy costs only gradually feed through. This makes long duration risky—until a decisive turning point.
If market sentiment shifts toward demand destruction, duration suddenly becomes asymmetrically attractive. Bonds then protect the portfolio again, regardless of whether oil prices fall or the economy stalls.
With moderate price increases, duration should be shortened; at extreme levels, it becomes a hedge. Today, a portfolio manager must know which regime he is in.
Oil and stocks: sector rotation and natural hedging
The stock market does not react to oil shocks as a monolithic block, but rather along deep sectoral divides. While energy and defense stocks are booming, airlines, automakers, and banks are coming under pressure. The key factor is the cause of the price spike: If oil prices rise due to a growing global economy, stocks follow suit. However, in the event of a supply shock – such as in the Strait of Hormuz – the correlation turns negative. In this scenario, energy exposure is not a directional bet but a necessary hedge.
The structural risk lies in the sector’s dwindling relevance. Energy producers now account for only 3% of U.S. market capitalization – down from 30% in 1980. As a result, the broader market has lost its natural hedge against energy costs. Anyone who invests passively in the S&P 500 today effectively holds an implicit short position in oil without receiving a premium for it. A targeted allocation of energy stocks and gold significantly reduces drawdowns during periods of market turmoil without diluting long-term returns. While electrification remains an issue for the future, the blockade in the Gulf is today’s risk.
Oil and currencies: the petrodollar feedback loop
Oil is traded in dollars, and that has consequences. Barclays estimates that a 10% rise in oil prices would strengthen the greenback by up to 1.0%. The logic is compelling: Rising energy costs increase demand for the dollar, while the currency simultaneously benefits from its status as a safe haven. This creates a tactical tension with our USD skepticism, which we have maintained since April 2025. In the short term, the oil shock is supporting the dollar; in the medium term, overvaluation and the high current account deficit continue to weigh on it. We are therefore maintaining a neutral stance on the USD allocation.
The Japanese yen deserves special attention. As a major energy importer, Japan is highly vulnerable: a 20% rise in oil prices reduces real GDP growth by 0.12 percentage points. This presents the Bank of Japan with a dilemma between fighting inflation and supporting growth. For our JPY position, which we established in February, this means short-term headwinds, even though the thesis of structural undervaluation remains intact. For the euro, energy dependence worsens the terms of trade and weighs on the exchange rate – a structural drag on our EUR bond allocation, which is, however, still cushioned by the current carry.
Summary: oil within ETHENEA's risk management framework
In November, we systematized our risk management into eight categories; oil affects at least four of them: market, inflation, currency, and concentration risks. It is not an isolated commodity issue, but rather a cross-cutting factor that simultaneously influences duration, credit quality, sector mix, and currencies. A portfolio manager does not have to trade oil – but he must be aware of the implicit oil price assumptions underlying his allocation.
Duration: In the early stages of an oil shock, the risk profile for long duration is negative – break-even rates widen, and nominal yields rise gradually. At extreme price levels that trigger a collapse in demand, the dynamics reverse.
Credit quality: The spread asymmetry of the overall market – tight on good news, wide amid growth concerns – argues for a defensive positioning during oil shock phases.
Equity exposure: Selective exposure to energy and commodities acts as a portfolio hedge during supply-driven oil shocks. Distinguishing between supply and demand shocks is crucial in this context.
Currencies: The dollar tends to strengthen when oil prices rise; currencies of major energy importers come under pressure.
The Iran conflict in March 2026 painfully exposed these dependencies. But even if the conflict is resolved, the underlying structure will remain: As long as the global economy remains dependent on fossil fuels, oil is priced in dollars, and production remains concentrated in unstable regions, crude oil will remain a top-tier systemic risk.
Settlement ultimately takes place in dollars. But the decision is made – as not only this past March but the entire postwar history teaches us – on the oil markets.
Note: This text was translated using AI and may contain translation errors. The German version of the text is authoritative.