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What happened?

The risk of wider conflict in the Middle East intensified on Friday after Israel launched strikes against Iran, targeting its nuclear facilities, military facilities, and senior military commanders. Israeli officials described the operation as a pre-emptive campaign to prevent Tehran from developing a nuclear weapon, claiming Iran had enough material to make multiple nuclear bombs within days.

News of the escalation sent crude prices sharply higher, with Brent crude rallying as much as 8.8% to USD 75.5/bbl on supply concerns. Gold prices rose 0.9% to around USD 3,415/oz. Asian equity benchmarks fell modestly, with the Nikkei closing 0.9% lower. The Stoxx Europe 600 is down 0.9% at the time of writing, while S&P 500 futures are 1.1% lower. Traditional safe-haven assets such as the US dollar, the Japanese yen, and Swiss franc all strengthened, and US 10-year Treasury yields fell 4 basis points to a five-week low.

Iran’s Supreme Leader Ayatollah Khamenei condemned the attack. Israel has declared a state of emergency in anticipation of retaliation and signaled that further strikes could follow. Meanwhile, US Secretary of State Marco Rubio said Israel had acted unilaterally, with no American involvement in the operation. Following the strikes, President Donald Trump pressed Iran to quickly reach a nuclear deal with the US.

What do we think?

The attack on Iran marks a significant escalation in regional tensions and comes after US-led negotiations to curb Iran’s nuclear program hit an apparent deadlock. Military exchanges last year between Israel and Iran were not followed by wider escalation. But in this instance, the magnitude of Iran’s immediate counterstrike on Israel, the extent of further Israeli attacks, and the potential involvement of the United States are crucial to gauge the potential for an escalation into a wider regional conflict.

With these responses yet unclear, near-term market volatility is likely. The Strait of Hormuz is a key artery for the global energy trade, with more than 20 million barrels of hydrocarbons passing the narrow shipping corridor each day, and the sharp spike in crude oil prices is a clear indication that market participants are concerned about supply losses. A risk premium in oil prices will likely persist until it becomes clearer how Iran and the US will react to Israel's attacks. If there are no supply disruptions, oil prices should fall again.

Below, we outline three potential scenarios, and how we would expect them to impact the global economy and financial markets. We highlight that these scenarios do not cover all eventualities, given the fluidity of the situation and the potential for miscalculations by the parties involved.

Scenario 1: Conflict remains contained mostly to Israel and Iran

In this scenario, further military exchanges between Israel and Iran continue in the coming days and weeks, and Israel’s allies help contain the threat from Iranian missile and drone attacks.

However, energy infrastructure in the wider region remains largely intact and maritime routes undisrupted—with any potential output loss from Iran made up for by bringing spare capacity elsewhere in the region back online. Renewed talks over the remains of the Iranian nuclear program may emerge, and markets will soon turn their attention back to trade policies and growth inflation dynamics.

In this scenario, the rise in oil prices would likely be temporary and short-lived enough not to affect global inflation dynamics meaningfully. Risk assets may experience some additional near-term downside, but would also likely recover quickly once it becomes clear that the conflict remains contained. This outcome would be consistent with our House View base case scenario, in which we expect weaker economic growth, but no recession in the US.

While attaching a probability to this scenario is difficult at this stage, history shows that the impact of geopolitical events on equity markets has tended to be short-lived. During the past 11 major geopolitical events (starting with the first Gulf War and ending with the Russia-Ukraine conflict), one week after the event, on average, the S&P 500 was just 0.3% lower, and 12 months later was on average 7.7% higher.

Scenario 2: Prolonged disruption to energy supplies

The most damaging scenario for the global outlook would be a prolonged disruption of energy supplies from the region. This could involve Iranian energy infrastructure being targeted, or Iran retaliating against US assets in the region and potentially energy infrastructure in the Gulf. This, in turn, would likely also trigger US strikes on Iran.

While the US has increased defense capabilities in the region, advances in drone technology and tactics likely mean that not all damage can be avoided, and maritime traffic through the Strait of Hormuz may be impacted for a considerable time. In such a scenario, the physical shortage of energy supplies would likely drive oil prices toward USD 90/bbl or higher, in our view, representing an additional price shock and adding to worries about the inflationary effects of US trade policy.

Global economic activity would suffer in such a scenario, though the ultimate impact would depend strongly on the duration of the energy supply disruption. The oil price may also see bigger swings if OECD countries decide to tap strategic reserves. Central banks would be put in a difficult position, needing to balance the potential impacts of higher energy prices on medium-term inflation dynamics with the disinflationary impact of fading growth.

Equity markets would likely see a rapid sell-off in this scenario as market participants price higher uncertainty and a weaker economic outlook. Safe-haven assets like gold, the Swiss franc as well as highly rated government bonds would likely perform well—for the latter especially those of countries where inflation dynamics have been subdued.

Scenario 3: Rapid escalation, quick recovery

A scenario of rapid escalation, which also draws in the United States, may lead to combined US and Israeli strikes on Iran’s nuclear and military capabilities. Energy supplies may be temporarily disrupted, some damage to the wider Gulf energy infrastructure may occur, and such strikes could potentially result in the military defeat of the Iranian regime.

Risk assets would likely sell off more strongly in this scenario than today’s immediate reaction, especially if and when the first disruptions to energy supplies are reported. However, a quick depletion of Iranian military capabilities would likely be followed by a strong focus on re-establishing energy supplies from the region, and risk assets markets may be quickly reassured by subsequent lower risks to regional oil supplies and trade.

How to invest?

The escalating conflict between Israel and Iran poses the risk of renewed cross-asset volatility. But past incidents suggest that if the conflict remains relatively contained and does not disrupt global energy flows, the market impact should fade fairly quickly as attention returns to underlying macroeconomic and policy fundamentals.

For investors, the key is to stay focused on long-term objectives and use market swings to build or rebalance risk positions where appropriate:

Navigate political risks: Gold’s reaction to the attack highlights the metal's role as a long-term portfolio diversifier. While some geopolitical risk premium was already priced before Israel’s attack, speculative positioning appeared relatively light, suggesting potential for further upside if negative headlines persist.

We continue to believe that gold remains a highly effective hedge against geopolitical risks. Ongoing US policy uncertainty is undermining the greenback’s ability to perform well when uncertainty is on the rise. This also applies to some degree to long-dated US government bonds, considering fiscal concerns. Lastly, the decline in crypto prices today is a reminder that they do not trade as classic “safe-haven” assets.

In addition to geopolitical factors, declining real interest rates and a longer-term trend of dollar weakness should continue to support gold prices. We maintain our USD 3,500/oz target and do not rule out the potential for prices to exceed this level if the conflict escalates. Our upside scenario price target is USD 3,800/oz. We recommend using near-term pullbacks to build or reinforce gold positions.

Phase into equities: Equities have performed well in 2025, and a lot of positive news on trade policy and economic growth appears to already be reflected in prices. So far, the Iran-Israel escalation has not significantly impacted equity market sentiment. However, increased near-term volatility could enable investors to gradually add to global equities or balanced portfolios. We focus on select US sectors including technology and health care; mainland China’s tech sector, India, and Taiwan in Asia; and on European quality stocks and our “Six ways to invest in Europe” theme.

Sell dollar rallies: As noted above, we see challenges to the USD’s traditional role as a safe-haven asset, and the dollar has only rallied modestly following today’s attack. We think any near-term dollar bounce is unlikely to be sustained, given ongoing ex-dollar global diversification and rising concerns over the US fiscal outlook.

We recently downgraded our view on the US dollar to Unattractive and recommend investors reduce excess US dollar cash by diversifying into other currencies such as the yen, euro, pound, and Australian dollar. With respect to currencies also considered safe havens, we favor the JPY over the CHF. The JPY’s valuation is cheap versus the CHF and the Bank of Japan is likely to raise rates, while the potential for negative rates looms in Switzerland.

Seek durable income: In periods of geopolitical escalation, some investors may be tempted to move into cash. But we think government bonds offer a credible alternative, allowing investors to lock in attractive yields while maintaining portfolio resilience.

We continue to see high grade and investment grade bonds as offering an attractive balance of risk and reward. Yields on quality bonds in most major markets remain compelling, and we expect the ongoing global rate-cutting cycle to support further investor inflows. Investment grade bonds are also appealing from a portfolio risk management perspective.