Financial Experts Warn Middle East Conflict Could Echo 1970s Economic Crisis

Investment professionals are growing concerned that the ongoing Middle East conflict could trigger a repeat of 1970s-style stagflation, where rising energy costs fuel inflation while simultaneously damaging economic growth. Oil prices have already jumped 70% this year, with Brent crude surpassing $100 per barrel.

Financial markets worldwide are grappling with fears that the current Middle East conflict could spark an economic scenario reminiscent of the 1970s, when energy supply disruptions caused inflation to soar while economic growth stagnated.

“The risk of a 1970s scenario is rising,” said Kaspar Hense, portfolio manager at RBC BlueBay Asset Management. “If there is another extended war, with oil prices going up significantly further, then the safe-haven status of government bonds are at risk, and with that, all assets.”

Energy costs remain at the heart of these concerns. Brent crude oil jumped past $100 per barrel on Monday, marking its largest single-day increase since the 2020 COVID crisis. The commodity has climbed 70% since January began, while European natural gas wholesale prices have reached their highest point in more than three years.

These price increases spell trouble for inflation rates. According to Capital Economics, “A useful rule of thumb is that a 5% rise in oil prices adds around 0.1 percentage points to developed market inflation.”

Rising energy costs also threaten to slow economic expansion. The International Monetary Fund calculates that each sustained 10% increase in oil prices typically leads to a 0.1-0.2 percent decline in global economic output. Historical data shows that oil price spikes contributed to U.S. economic downturns in 1973, 1980, 1990 and 2008.

This situation creates a challenging predicament for central banks, as raising interest rates to combat inflation could further damage economic growth. Chicago Fed President Austan Goolsbee warned the Wall Street Journal on Friday that a “stagflationary environment that’s as uncomfortable as any” could be approaching.

Market expectations for monetary policy have shifted dramatically. Traders now anticipate at least one European Central Bank rate increase this year, compared to a 40% probability of a rate cut before the conflict began. Similarly, markets now see potential for a Bank of England rate hike this year, having previously expected at least two rate reductions.

“It seems only retreating oil prices could reverse rate hike fears, even with dovish minds at the ECB also stressing downside growth risks,” said Commerzbank rates strategist Rainer Guntermann.

Global bond markets have suffered as investors abandon fixed-income securities, where inflation diminishes future returns. Short-term bonds face the greatest pressure. British two-year government bond yields have surged nearly 50 basis points over the past week, representing their worst performance since the 2022 budget crisis, amid the UK’s persistent inflation and stagnant growth.

German and Australian two-year yields have increased more than 30 basis points during the same period, while U.S. two-year yields rose a relatively modest 13 basis points.

These conditions have driven investor interest toward inflation-protected securities, where both principal and interest payments adjust with inflation rates. British five-year breakeven inflation rates have climbed 28 basis points since February ended, reaching nearly 3.5% on Monday – their highest level since last April.

Market observers questioning whether economic pressures might influence U.S. President Donald Trump’s policies should note that America may experience less severe stagflationary effects than Europe or Asia.

“The U.S., with the Americas, is self-sufficient in many (of the) commodities being choked off directly or indirectly via (Strait of) Hormuz,” explained Rabobank senior global strategist Michael Every. Beyond oil, he highlighted fertilizer and helium, which plays a crucial role in semiconductor production.

American markets have demonstrated relative resilience. The S&P 500 declined 2% last week, compared to a 5.5% drop in Europe and a 6.3% fall for MSCI’s Asia Pacific ex-Japan index. U.S. bonds also performed better than German securities last week.

However, America remains vulnerable to stagflationary pressures and showed some weakness even before energy prices spiked. The economy unexpectedly lost jobs in February, and upcoming data releases are expected to reveal higher U.S. inflation.

Stagflation presents challenges for investors because it damages both stocks and traditional bonds while potentially affecting even gold, given its lack of yield. The precious metal fell 2% last week and continued declining Monday, though analysts attributed some selling to investors covering losses in other areas.

The dollar has emerged as the primary safe haven since the conflict began, gaining strength against nearly all other developed market currencies.

“The U.S. is a major oil producer and can withstand an oil shock – though there will be political fallout,” said Kit Juckes, head of FX strategy at Societe Generale. “The same simply isn’t true of Europe, and the UK in particular.”