Oil between geopolitical vulnerability and structurally declining dependence

Oil between geopolitical vulnerability and structurally declining dependence

Few commodities have shaped the global economy as profoundly as oil. To this day, fluctuations in oil prices influence growth, inflation, monetary policy and financial markets, albeit the mechanisms are slightly different compared to the oil crises of the 1970s. Abrupt price shocks in particular can therefore have repercussions far beyond the commodities market and put pressure on the economy and financial markets.

Since the 1970s, the global economy’s direct dependence on oil has declined structurally. Technological progress, greater energy efficiency and the development of alternative energy sources mean that economic growth now requires less oil per unit of output. At the same time, rising US shale production and a more diversified supply base outside the Middle East have increased flexibility on the supply side, whilst inflation expectations are more firmly anchored. Oilprice shocks are therefore generally less disruptive than in previous crises, although their effects vary considerably across regions, sectors and asset classes.

The oil market remains vulnerable where geopolitics intersects with concentrated production and transport routes. The recent tensions surrounding the Strait of Hormuz serve as a reminder that an abrupt supply shock remains a possibility at any time. For portfolios, such a shock is a significant risk factor: rising oil prices can fuel inflation expectations, weigh on equities and, at the same time, put bonds under pressure. This can significantly reduce the stabilising effect of traditional equity-bond portfolios. This makes broad diversification across asset classes and regions, careful security selection and disciplined risk management all the more important.

Allocation: positioning amid monetary policy uncertainty and rising interest rates

The macroeconomic environment remains late cycle but fundamentally resilient. The US economy continues to prove robust despite slowing consumer momentum, while Europe is losing pace and moving closer to recession. Ample liquidity and high fiscal spending continue to support economic activity and corporate earnings. At the same time, inflation data have come in higher than expected and uncertainty surrounding the future direction of US monetary policy has increased. Under Fed Chair Kevin Warsh, the design of forward guidance and the future direction of the Federal Reserve’s balance sheet policy are moving into sharper focus. Less reliable communication of the interest rate path or a renewed phase of quantitative tightening could weigh on market liquidity and intensify upward pressure on long term nominal and real interest rates. High fiscal deficits and growing bond supply, including issuance by large technology companies, could exacerbate this trend.

Against this backdrop, we have deliberately reduced risk within the allocation while increasing our tactical flexibility. We We have scaled back our previously strong overweight positions in Swiss property and gold but remain overweight in both asset classes. In Swiss property, increasingly demanding valuations and growing supply from IPOs and additional capital raises support a more cautious stance. Rising interest rates could place further pressure on valuations. Legal and regulatory uncertainties in Switzerland also remain a concern. In gold, we have realised part of the accumulated gains. The long-term case for gold remains intact given geopolitical risks, high fiscal deficits and the potential for currency debasement. However, higher real interest rates could create short-term headwinds. We are holding the released funds in cash for the time being, allowing us to capitalise selectively on investment opportunities during the second half of the year. We remain neutral on equities. At sector level, we are reducing consumer staples, as higher commodity costs and weaker real incomes could weigh on margins. At the same time, we are increasing information technology following improved valuations and greater confidence in earnings growth. We remain underweight in bonds and cautious on duration. Persistent upward pressure on interest rates and tight credit spreads continue to offer an unattractive risk-return profile.

The anatomy of oil shocks: history, mechanics and impact

Since the 1970s, oil price shocks have been a recurring source of stress for the global economy. This began in 1973 with the OPEC embargo, which brought the era of cheap energy to an end and caught the industrialised nations at a time of high oil dependency. This was followed by a combination of weaker growth and high inflation, which made stagflation a central issue in economic policy. When the Iranian Revolution triggered a second major oil price shock in 1979 and further intensified inflationary pressures, central banks were forced to tighten monetary policy on a historic scale. The Volcker shock – a radical interest rate hike by the US Federal Reserve – broke this inflationary spiral, but in doing so triggered the most severe recession since the Great Depression. Subsequent episodes were milder. Although the 1990–91 Gulf War triggered a sharp price spike, prices quickly returned to normal, helped by the coordinated release of strategic oil reserves. The rise in oil prices prior to the 2007–08 financial crisis was, for the first time, not due to a supply bottleneck but to strong demand from China, before the crisis caused prices to collapse just as rapidly. A demand-driven slump occurred in 2020, when the pandemic paralysed the global economy and temporarily pushed oil prices to historic lows. The Russia–Ukraine war caused the oil price to rise significantly again in 2022, but this time the global economy weathered the shock better than feared. The recent tensions surrounding the Strait of Hormuz also fit into this pattern and serve to highlight that geopolitical risks remain present in the oil market.

The economic impact of an oil price shock depends not only on its magnitude, but also on its causes. Broadly speaking, shocks can be categorised as either supply-side or demand-side, each having very different effects on growth, inflation and financial markets. In the case of a negative supply shock, oil suddenly becomes scarcer, for example due to war, sanctions, production outages or coordinated production cuts by OPEC+. As households and businesses are largely unable to adjust their energy consumption in the short term, even minor supply shortfalls trigger disproportionately large price spikes. From a macroeconomic perspective, such a shock acts as a cost shock: production and logistics become more expensive, margins come under pressure and part of the higher costs is passed on to consumers. Households’ real purchasing power falls, consumption is dampened and growth loses momentum, whilst inflation rises. This creates a dilemma for central banks between combating inflation and supporting the economy. If such a shock hits an already strained economy or coincides with a restrictive monetary policy, it can trigger or exacerbate a recession. A positive demand shock has a different effect. If the oil price rises due to strong demand, this does not initially signal a supply shortage, but rather robust global demand, driven, for example, by strong growth in industry, trade and transport. In this phase, the higher oil price is often a by-product of an expanding global economy and goes hand in hand with rising corporate turnover, higher investment and a solid appetite for risk on the financial markets. Only when the oil price reaches a level at which energy expenditure crowds out other consumption and investment expenditure does its effect reverse. Then the economic signal turns into a drag: margins come under pressure, real incomes fall and global demand loses momentum. The opposite scenario is a negative demand shock, in which an economic slump such as that seen in 2008 or 2020 causes the oil price to plummet. However, this decline provides little relief to the economy, as it is not the cause but rather a symptom of a widespread crisis.

The impact of oil price shocks has changed over the decades. Today, the global economy consumes around 60 percent less oil per unit of economic output than it did in the 1970s. This is due to more efficient technologies, the growth of the service sector and the increasing replacement of oil with other energy sources. The direct impact on consumer prices has also declined, as energy carries less weight in the consumer basket of many industrialised countries. Nevertheless, higher oil prices can still make many goods and services more expensive by increasing production, transport and supply chain costs. In the United States, shale oil production has also strengthened resilience by reducing dependence on oil imports and encouraging investment in the energy sector when prices rise. Europe and parts of Asia remain more vulnerable because of their greater dependence on imports. At the same time, more stable inflation expectations and less frequent automatic wage adjustments reduce the risk of a sustained wage-price spiral. The global economy has become more resilient to oil price shocks, but it is not completely immune.

Oil shocks and the interplay between asset classes

Oil price shocks are particularly relevant to investors because they can alter the usual relationships between asset classes. The correlation between equities and bonds is not a stable state, but rather a reflection of the prevailing macroeconomic regime. In growth-driven downturns, high-quality bonds usually act as a counterbalance: falling economic expectations dampen inflation expectations and increase the likelihood of monetary easing, leading to falling yields. This causes bond prices to rise, and losses on shares can be at least partially offset. In inflationary regimes, this logic is reversed. Rising prices force central banks to adopt a more restrictive monetary policy; yields and real interest rates rise, and higher discount rates weigh on both equities and bonds simultaneously. Supply-driven oil shocks can exacerbate precisely this environment. They increase inflationary pressure and limit central banks’ scope to respond to weaker economic signals with easing measures. Consequently, what starts as an economic headwind turns into an interest rate and inflation shock for the financial markets. The result is a higher correlation between equities and bonds and a reduced diversification effect of traditional mixed portfolios.

Gold plays a special role, although this is not always immediately apparent. In the short term, the precious metal may come under pressure in the wake of a supply-driven oil shock. The inflationary impulse initially causes nominal interest rates to rise. If the market subsequently prices in a more restrictive monetary policy, real interest rates also rise, thereby increasing the opportunity cost of the non-interest-bearing precious metal and making interest-bearing investments relatively more attractive. However, this headwind may be overshadowed by geopolitical uncertainty, as gold is also sought out as a safe haven during periods of acute stress. Gold reveals its true strength when the shock turns into an economic risk and central banks face the dilemma of balancing inflation control with economic support. If, in this environment, real interest rates fall, monetary easing looms, or inflation uncertainty remains high, gold gains in importance as a store of value. Similarly, the Swiss franc acts as a hard currency: during periods of global stress, it benefits from safe-haven demand, monetary policy credibility, low inflation and a structural current-account surplus. Gold, as a real store of value, and the franc, as a stable hard currency, thus form a potential counterbalance when the usual diversification via shares and bonds loses its effectiveness.

An oil price shock is therefore more than just a macroeconomic event. It is a stress test for the entire portfolio architecture. What matters is not only how broadly a portfolio is diversified across asset classes, but whether these components are in fact subject to different risk drivers in the event of an inflationary shock. If rising energy prices drive both inflation and real interest rates at the same time, equities and bonds can come under pressure simultaneously. Whilst formal diversification remains in place, its effectiveness diminishes. Robust portfolios therefore require components that are not affected to the same extent by the common factor of inflation. Oil price shocks thus reveal whether diversification exists only on paper or whether it holds up even during periods of disrupted correlations.

What oil shocks mean for equity markets

An oil price shock is relevant to share markets because it alters the expectations on which share valuations are based. A share price reflects not only the current earnings situation, but also the present value of future cash flows. This present value essentially depends on two factors: expected profits and the interest rate at which these profits are discounted. A sharp rise in oil prices can put pressure on both factors simultaneously. At the macroeconomic level, it weighs on expectations because investors have to factor in higher inflation, weaker purchasing power and slowing growth. At the same time, rising real interest rates or a more restrictive monetary policy can increase the discount rate. This results in future profits being discounted more heavily, which weighs on the valuation of the stock market as a whole. The second factor – expected profits themselves – does not, however, have a uniform effect, but varies significantly across the market depending on the business model and sector.

Authors:
Samuel Nibali
Lars Fluri

Editorial deadline: June 22nd, 2026

The prices used in our analysis are end-of-period prices. The figures used for our valuation model are estimates referring to dates and therefore carry a risk. These are liable to change without notice. The usage of valuation models does not rule out the risk that fair valuations over a specific investment period cannot be attained. A complex multitude of factors influences price developments. Unforeseeable changes could, for instance, arise from technological innovations, general economic activities, exchange-rate fluctuations or changes in social values. This discussion of valuation methods makes no claim to be complete. Dreyfus Sons & Co Ltd, Banquiers publishes Compass four times a year since June 2008. The publication is aimed at clients of the bank and interested parties. It describes some of the instruments and methods the bank uses to monitor everything to do with the financial markets. A description of the investment process can be obtained from your client advisers or our website. Compass provides guidance but cannot take the circumstances of an individual portfolio into account. It is for information and marketing purposes.

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