Monday Digest

Posted 23 March 2026

Escalation precedes de-escalation
The marked escalation in the Iran conflict, which began with Israeli-US strikes against the Iranian Pars gas field followed by reprisals against Qatari gas sites and other neighbours’ key oil producing assets, has now become even hotter. This weekend has seen both threats of a yet worse escalation and an increase in actual strikes, with Iran firing ballistic missiles at an Israeli Nuclear power plant. Trump has set a deadline of Monday night for Iran to cease blocking the Straits of Hormuz. Iran has made no sign of complying and threatened a devastating and long-lasting cost on its neighbours.

Interestingly, spot Brent crude oil is opening this morning still below Wednesday’s high although European and Asian natural gas prices are making new highs since the peak of the Ukraine invasion.

This has forced markets to reconsider their optimism about the extent of the war. Both stocks and bonds are struggling. This is a disruptive phase for markets, but there are reasons to be hopeful. The subtext of Trump’s threat to “blow up” South Pars was disapproval of Israel’s initial strike – backing up the idea that Trump wants an off-ramp, and further evidenced by a Friday White House briefing that the objectives were nearly achieved and they wanted to reestablish diplomatic dialogue. Israel has its own objectives – potentially conflicting with the US and Arab allies – but the US has a strong incentive to de-escalate. It’s nervy for markets regardless; every day without resolution looks like a bigger economic threat. 

The fear factor is having strange effects on currencies and gold. Prices for the stereotypical ‘safe haven’ have dropped 10% since the war. Recent speculative gold buyers might wonder what’s going on, but we suspect it’s a liquidity grab: if gold is an insurance policy, you cash it in in emergencies. 

Bonds have been mixed. Government yields are up – consistent with an inflation spike but inconsistent with a growth scare. Credit spreads are not faring badly, again inconsistent with a growth scare (excepting worse-hit Europe). It looks like some of the weaker credits were already squeezed out ahead of the oil shock.

The Fed, the BoE and the ECB all issued inflation warning – the BoE even suggesting it could raise interest rates. That’s probably more inflation expectation management than actual policy signal. The BoE will welcome marginally higher wages from February, but past data is basically irrelevant now. The Fed is projecting stability (and one rate cut this year) despite the fact the US looked more inflationary than expected even before the war.

Higher risks and tighter monetary policy mean a market liquidity squeeze, even if geopolitics improve. But underlying growth still gives reason for optimism. If energy infrastructure avoids extensive damage – and countries invest in closer and cleaner energy – it could reverse the current stagflation narrative. 

China projects stability
China’s new five-year plan, unveiled at this month’s National People’s Congress (NPC) set a national growth target of 4.5%-5%, meaning 4.5%. That’s the lowest since 1991, but if the world’s second-largest economy achieved it amid population decline, it would be impressive. The NPC recognised a need to better stimulate domestic demand with a ¥100 billion “fiscal-financial coordination fund” and “appropriately accommodative” monetary policy (deficit spending is still capped at 4% of GDP). Alongside consumption support, the NPC committed to growing R&D spending 7% annually over the next five years, as Beijing accelerates its “AI+” initiative for widespread AI adoption. 

We shouldn’t doubt Beijing’s commitment to boosting demand, but its ability to do so is still debatable. Its typical growth lever – production – has only worsened China’s oversupply, and an R&D push could do the same if it doesn’t change the excess savings problem. The property market overhang looks like it’s clearing up at least (back orders being completed and prices projected to stop falling) and company pricing power is finally improving. Beijing’s fiscal support is a welcome addition, but we shouldn’t overstate the spending. Much of the recent debt expansion has just been the central government taking over local government ‘shadow loans’. 

Overall, the five-year plan is about stability: consumption support but no ‘bazooka’; monetary accommodation but no 2010s credit bubble. Stable is how China presents itself internationally too, amid erratic US policy. Beijing keeps talking about Taiwan, but an invasion in the medium-term would degrade China’s ‘adult in the room’ image. A strong renminbi is part of this. Beijing has guided it higher for a while, and it’s now clear that the pressures on the currency to fall are dropping away. That lessens deflationary pressures and ‘dumping’ allegations from the west. That’s helping capital inflows. Beijing will want this to continue. 

Structural weakness in UK government debt
UK government bonds (gilts) are seen as more inflation-sensitive. That’s largely about the gilt market’s structural weakness: historical pension fund demand for long-dated gilts caused the government to shift issuance long-term (exacerbated by quantitative easing), leaving the UK with one of the highest average weighted maturities of any big economy. The decline of defined-benefit pension schemes lessened demand for long-term gilts, setting the scene for the ‘Liz Truss episode’ (exacerbated by quantitative tightening). The imbalance pushed the government to issue more at the short end, but that increased the refinancing risk – making government finances more sensitive to interest rates and inflation. 

Then there’s the fact that around a quarter of outstanding gilts are inflation-linked – much higher than other countries. The feed-through from inflation to inflation-linkers is complicated. A short-term inflation shock doesn’t actually increase short-term debt repayments too much (they are smoothed to maturity) but it does push up the current accounting value of those repayments. An inflation shock in 2026 would be recorded, by the OBR, as a big increase in UK debt repayments, even though extra cash payments in 2026 would be small. 

Volatility in reported debt repayments increases the sense that UK finances are fragile. The UK’s actual debt metrics are relatively favourable compared to other economies, but volatile perceptions mean volatile gilts. Of course, gilt pessimists might tell you it’s about flawed government policy (indeed, our measure of implied credit risk is higher for the UK than elsewhere) or propensity to increase debt amid an energy crisis. But that doesn’t make much sense when you compare likely UK policy to France or Japan, whose bonds haven’t swung as much. 

Basically, the underlying metrics suggest that gilt traders overreacted to the oil shock – compared to other bond markets. You’d expect gilts to calm down, but the market is undeniably fragile.