The Iran war and its potential ramifications for the global economy kept markets on edge. Investors welcomed news reports around mid-week suggesting that talks with Iran were on the table. But as the conflict neared the end of its fourth week, there was a sense of heightened attention on the longer-term domino effect that could knock down economic growth, push up inflation, and compel central banks to hike if the surge in oil prices doesn’t relent. Markets have begun pricing in higher interest rates. The 10-year Treasury yield rose to fresh year-to-date highs this week, and the CME Group’s FedWatch Tool indicated that investors viewed rate hikes as a new possibility in the spring and summer. Beyond that, the picture was mixed—consistent with expectations that energy costs will decline over time. Brent crude for October delivery traded around $12 a barrel cheaper than the front-month contract during Wednesday trading.

Central banks from the U.S. to Europe have expressed a desire to wait and see how the surge in energy prices pans out. Like the Federal Reserve, the European Central Bank left rates unchanged last week. Still, President Christine Lagarde cautioned on Wednesday that a “measured” adjustment to policy rates could be appropriate if the oil shock leads to higher inflation. “To leave such an overshoot entirely unaddressed could pose a communication risk: the public may find it difficult to understand a reaction function that does not react,” Lagarde said.

PGIM’s Weekly View from the Desk considers the global effects of the Iran war through country sensitivities from several aspects, including exposure to Gulf energy imports, tail risk buffers, and policy scope in the context of macro conditions.