The Iran war underscores an emerging risk for global portfolio investors: with the end of globalization, financial market prices will increasingly be determined by geography, security considerations, and geopolitical alignment. The stability that those rules underpinned for financial markets in the past is not guaranteed anymore.
For an example, look no further than the yawning gap in the Brent – West Texas Intermediate (WTI) crude oil spread. Global oil prices even after the war ends are likely to carry a security risk premium now that chokepoints and fragilities – like the Strait of Hormuz, the gateway for about a fifth of the world’s shipped oil – have been revealed. The urgency to make energy supply chains more resilient across the globe will be an overriding priority.
Unsurprisingly, market-based volatility has risen notably since late February. In the U.S., interest-rate volatility, as measured by the MOVE Index, has jumped, pointing to growing concerns about the changed outlook for monetary and fiscal policy and the fragility of global liquidity in fixed income markets. Similarly, equity volatility, as measured by the VIX, has shot up.
What is unfolding now is not just another geopolitical flare-up that will soon subside. Instead, the rules governing the global economic and financial system are being rewritten in real time. The previously overlooked impact of fragmentation – the breaking up of global energy markets, trade and finance – is becoming an active driver of market dynamics. That creates challenges for central banks and policymakers.
Energy Market Fragmentation
Earlier this month, the International Energy Agency classified the conflict in Iran as the largest supply shock in the history of the global oil market. Now, investors are reassessing previously benign assumptions about how long the conflict will last, how severe the damage to critical infrastructure might be, and how further disruptions might impact broader commodity markets over the medium term.
That reassessment is exposing what could become a more fundamental shift. The widening spread between WTI and Brent may be temporary, reflecting stress in financial markets and inability of financial intermediaries and commodities trading firms to arbitrage it away. But it could prove more persistent — a level shift along the entire curve— reflecting regional supply-demand imbalances, logistical constraints, and the costs associated with building more resilient supply chains. Dislocations are also emerging along the refined products chain, with growing spreads among crude, gasoline, diesel, jet fuel, and shipping fuel quotes.
LNG markets are showing similar stress. Europe, already vulnerable due to its dependence on imported energy, has seen prices surge following Qatar’s decision to halt a significant portion of production at its Ras Laffan complex after missile damage.
Market Volatility and Central Bank Decision-Making
It’s not just that market volatility is rising across asset classes and geographies – there are more subtle disruptions at work. For example, in U.S. stock markets, the so-called volatility risk premium—the difference between option-implied volatility and an estimate of expected volatility—has increased. This suggests that investors are becoming more risk averse, requiring additional compensation to bear volatility risk in equity markets.
For central banks and investors, the challenge is how to interpret signals from asset prices against a backdrop of rising financial stress and market fragmentation. The sequence of the rupture also matters: it has affected physical markets (goods) first, while financial markets, though more fragmented, can still transmit shocks globally.
In recent years, global central banks in advanced economies opted for an opportunistic slow squeeze of post-pandemic inflation. But they are signaling increasing unease about the inflationary implications of the conflict.
The Reserve Bank of Australia has already tightened policy, and others are hinting that rate increases may be necessary. For institutions like the ECB, which have a single mandate focused on price stability, there may be limited tolerance for looking through energy-driven inflation spikes.
Investors face similar concerns: Long-term interest rates have risen sharply, likely reflecting not only inflation uncertainty but also a growing fiscal risk premium. Governments are facing mounting pressure to increase spending on defense and to invest in more resilient supply chains. These needs are colliding with already stretched fiscal positions.
In the U.S., where the Treasury has decided to continue to rely on short-term instruments, the risk of rollover is becoming more salient. Higher interest rates are also amplifying concerns about the credit outlook, particularly in corners of private credit that are sensitive to financing costs. Additionally, political divisions in the U.S. are constraining the government’s ability to respond decisively across foreign policy or economic management.
Consequently, there is a growing disconnect between rhetoric and action. For markets, this creates a level of uncertainty that is particularly difficult to price. Economists often refer to this as Knightian uncertainty, where the probability of possible outcomes is not quantifiable.
Persistent Supply Shocks
Between the pandemic, the war in Ukraine, trade tensions, and now the Iran conflict, the global economy has been subject to a series of major supply shocks over just a few years. Each of these shocks has contributed to a more inflation-prone environment and a more complex policy landscape. As Federal Reserve Chair Jerome Powell commented in 2025: “We may be entering a period of more frequent, and potentially more persistent, supply shocks—a difficult challenge for the economy and for central banks.”[1]
If central banks are forced to hike in the event of rising medium-term inflation expectations, the resulting tightening in financial conditions could expose cracks in the financial system.
The regional implications are also uneven. The U.S., as a net energy exporter, is relatively better positioned to absorb the shock. In contrast, Europe and much of Asia — which rely heavily on imported energy — are more exposed to sustained price increases and supply disruptions. This divergence could further widen economic, financial and policy gaps across regions.
Most importantly, the tools that policymakers have relied on in the past, which work to mitigate demand shocks, are becoming less effective in navigating this new supply-shock-prone environment. Likewise, the tools that investors have relied upon in the past to manage risk are likely to be less useful in this context.
Central banks and investors are going to have to adjust — not just to a single event, but to a world in which uncertainty is higher, global capital markets are more fragmented and the price of risk remains structurally elevated.
A version of this blog first appeared on MarketWatch.
[1] “Opening Remarks,” At the Second Thomas Laubach Research Conference, hosted by the Federal Reserve Board, Washington, D.C.
