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Supply disruptions emanating from the Middle East conflict have piled onto inflation pressures that were already bubbling under the surface. This week’s central bank run lays bare the bind policymakers face between reining in inflation and supporting growth and jobs. We think higher yields are here to stay – and that long-term government bonds are no longer effective diversifiers against equity declines. We stay overweight U.S. and EM equities on the rapid AI buildout.
Markets projected U.S. rate cuts before the Iran war erupted – and ignored signs that inflation’s downward trend had already stalled as core services inflation remained stubbornly high (see the chart’s inset on the right). The reason: An aging population and immigration curbs make for a tight labor market. Add the AI-led capex boom and tariff-driven goods inflation, and it becomes clear why broader core inflation is running above central bank targets.
Markets flipflopped when the Middle East supply disruptions caused price spikes in energy and base chemicals. They are now pricing out U.S. rate cuts this year and expect the European Central Bank to hike instead of staying put. This shift reflects a recognition that inflation is running above pre-pandemic levels – a trend we see persisting for now.
The big picture is that we are in a world shaped by supply. The Middle East conflict has supercharged existing supply constraints and intensified mega forces – structural changes such as the energy transition, geopolitical fragmentation, and AI disruption. Supply disruptions of energy, chemicals, and other industrial materials are increasing inflation pressures, albeit with disparate effects across regions.
Europe and parts of Asia are feeling the brunt given their dependence on imported energy. The U.S. is more shielded as a net energy exporter. The conflict is reinforcing the resolve of governments around the world to invest in energy security and defense, adding to towering debt loads and putting upward pressure on inflation.
At the same time, an accelerating AI buildout is creating outsized demand for energy, data centres, and specialized labor. This is bumping into worsening capacity and political constraints that are increasing costs. Prices of key AI inputs such as semiconductors are rising as capacity struggles to keep pace with demand. We think AI’s productivity gains could quickly offset such “chipflation” and other price pressures – and push down inflation. But this hasn’t happened yet.
Such is the backdrop for the Fed and other major central banks as they meet this week. They face a stark tradeoff between trying to bring down inflation or supporting economic growth and jobs. No change in policy rates is expected, and the key is to watch for signs whether policymakers are growing concerned about persistent inflation, even if they look through price pressures caused by Middle East supply disruptions.
We stay risk-on in this environment. We are overweight U.S. and EM equities as major AI firms are now showing they can monetize their tools. We stay underweight long-term government bonds. They struggled to offset equity declines throughout the Iran war. This underscores the “diversification mirage” outlined in the Q2 update to our 2026 Global Outlook: This is a structural feature of the post-pandemic environment as the term premium – the extra compensation investors demand for holding long-term bonds – rises on concerns over high debt loads.
We prefer short-dated credit and Treasuries for quality income instead, and EM hard-currency debt as it leans toward commodity exporters benefiting from supply disruptions.
We prefer stocks over bonds as we see inflation pressures keeping interest rates higher for longer. We also eye thematic opportunities across power and infrastructure on AI demand and a scramble for energy security.
Jean Boivin is Managing Director, Head of the BlackRock Investment Institute at BlackRock Inc.
Wei Li, Global Chief Investment Strategist, Blackrock Investment Institute at BlackRock Inc., Nicholas Fawcett, Senior Economist – BlackRock Investment Institute, and Tom Becker, Portfolio Manager, BlackRock Multi-Asset Strategies and Solutions, contributed to this article.
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Content copyright © 2026 BlackRock Inc. All rights reserved. iSHARES and BLACKROCK are registered trademarks of BlackRock, Inc., or its subsidiaries in the United States and elsewhere. This article first appeared April 27, 2026, on the BlackRock website. Used with permission.
This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of the date indicated and may change as subsequent conditions vary. The information and opinions contained in this post are derived from proprietary and nonproprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This post may contain “forward-looking” information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any of these views will come to pass. Reliance upon information in this post is at the sole discretion of the reader.
Image: iStock.com/Theeraphat Uamduang
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