Key points

• Sustained energy disruptions pose challenges to economic growth, inflation and monetary policy, with Europe most vulnerable to a stagflationary shock.

• Energy‑driven supply shocks are likely to delay rate cuts, particularly in the US.

• Geopolitical uncertainty may pressure both equities and bonds at the same time, reinforcing the case for long‑term discipline amid market volatility.

The ceiling for oil prices, and how long they’re high, is likely to be a matter of how long the conflict in Iran lasts. Prolonged hostilities would amplify economic effects and could further test investor resolve.

Vanguard analysis suggests that although the US and global economies remain resilient, the scale and persistence of energy disruptions raise noteworthy risks for growth, inflation and central bank decision‑making.

The chart below shows how quickly and significantly the oil shock has taken hold.

Oil prices and premiums spike during conflicts

Notes: The front contract versus six-month-out contract premium/discount is a market-based measure of risk premia.
Sources: Vanguard calculations, based on Bloomberg data, as at 9 March 2026.

The surge in oil prices and market‑based geopolitical risk premia have moved rapidly towards levels seen during the First Gulf War in 1990 and the Russia–Ukraine conflict in 2022. At those times, prices and risk premia rose sharply, remained elevated for several months and gradually subsided only as supply conditions stabilised.

Transportation, insurance and storage constraints are limiting export capacity throughout the Middle East energy complex, beyond oil production. If these constraints persist in a similar way to situations in the past, macroeconomic consequences could become increasingly challenging.

If crude oil and natural gas disruptions, and the associated uncertainty, persist as they did in 1990 or 2022, the macroeconomic spillovers would become increasingly stagflationary. Sustained energy price shocks could push inflation higher, tighten financial conditions and complicate policy trade‑offs.

Where higher-for-longer oil price effects would be felt most acutely

The costs of higher‑for‑longer oil prices would be felt most acutely in the euro area and Japan. Oil at $125 per barrel and natural gas at €150 per megawatt hour sustained for the rest of the year could trim a percentage point off euro area real GDP and drag the economy into recession.

Sharply higher energy prices risk a stagflationary shock to the European economy. Given this development, the European Central Bank may be forced to reassess its policy stance. Our bias is no longer to the downside.

The US economy’s underlying strength

Our research, however, highlights the underlying strength in the US economy. To induce a US recession, oil prices would need to remain at $150 per barrel the rest of the year, and there would need to be a significant tightening of financial conditions, such as weaker asset prices and higher interest rates.

The table below shows the anticipated economic effects of higher oil prices. Our assessment relies on history as a guide and considers variables such as offsetting impacts of fiscal and monetary policy. The effect on euro area inflation would be even greater if natural gas prices were also sustained at high levels.

Europe and Japan more vulnerable than US to protracted high oil prices

Notes: Bps stands for basis points. A basis point is one-hundredth of a percentage point.
Sources: Vanguard calculations, based on Oxford Economics and US Federal Reserve data, as at 9 March 2026.

The US economy is comparatively well-positioned to absorb an energy shock, especially one that is short‑lived. With household balance sheets, labour markets and corporate fundamentals relatively strong, a de‑escalation of the conflict and a subsequent easing in oil prices could allow markets and economic activity to rebound. In that scenario, tighter financial conditions and weaker sentiment would likely unwind, limiting the risk of lasting damage and enabling a quicker snapback in growth and financial markets.

How the US Federal Reserve is likely to respond

For now, continued conflict in the Middle East and high oil prices will likely tie central banks’ hands. Energy‑driven supply shocks are not something that monetary policy is designed to address. Both sides of the US Federal Reserve’s (Fed’s) dual mandate fall under pressure. As long as it lasts, we would expect the Fed to have a bias towards inaction, although already elevated inflation will keep policymakers vigilant to potential changes in inflation expectations.

Elevated oil prices would likely push out the timeline for rate cuts. Vanguard foresees just one Fed rate cut in 2026, a view that financial markets have adopted amid the conflict.

For the duration, investors will need to be prepared for what may lay ahead.

Geopolitical uncertainty can pressure both equity and bond prices at the same time, even when the underlying economy is resilient. Maintaining perspective and staying committed to a long‑term strategy is a way for investors to navigate volatility and participate in any eventual rebound.