The Middle East conflict is increasingly influencing expectations for growth, inflation and interest rates. Below, we review the latest developments, how they are beginning to show up in the data, and how markets and central banks are responding.

Middle East: Awaiting Clarity

Now in the fourth week of what U.S. officials initially framed as a four-to-six-week operation in Iran, time remains the central variable. Mixed messaging from the U.S. and Iran’s apparent inclination to prolong tensions continue to obscure expectations around the conflict’s duration.

A potential opening for de-escalation emerged this week after U.S. President Trump announced a five-day halt in strikes on Iranian infrastructure, followed by a “15-point” peace framework delivered to Iran. Whether this reflects the start of diplomatic reengagement is unclear. Limited domestic support and rapidly rising fuel prices should incentivize the U.S. to pursue an off-ramp, while Iran’s interest in preserving the regime and critical infrastructure could eventually support a return to negotiations. However, despite somewhat more constructive signals, Iranian officials continue to deny that substantive talks are underway.

For markets, commodity prices, particularly oil, remain the primary transmission channel. The world economy has weathered high oil prices before, but the speed of the recent increase, coupled with disruptions to a key trade route (the Strait of Hormuz), makes this episode more challenging. Greater visibility on the conflict’s trajectory and commodity price pressures will likely be required before markets can stabilize more durably. We continue to watch for more credible signs of de-escalation.

Economic Impact: Moderation Underway

Prior to the conflict, the global economy was showing improving momentum, with business activity strengthening across both manufacturing and services and economic data broadly surprising to the upside.

Recent releases now offer an initial look at how conditions may be shifting. In the U.S., growth appears to have eased slightly, with rising cost pressures and softness in services activity. Manufacturing has held up somewhat better, likely supported by inventory building ahead of potential supply disruptions and diminished tariff concerns. Meanwhile, growth indicators for Europe have weakened more noticeably, while input costs have risen more sharply, reflecting the region’s greater reliance on imported energy. For now, overall activity levels remain consistent with continued, albeit slower, economic expansion.

Central Banks: A Cautious Approach

Against this backdrop, the interest rate outlook has shifted as markets incorporate the inflationary impact of higher energy prices, scaling back expectations for rate cuts. Although this reaction is sensible, it may be placing too much focus on near-term price pressures. While higher oil prices lift inflation, they also drag on growth by reducing consumer spending, which tends to be disinflationary over time. In addition, monetary policy is not well equipped to address supply-driven price shocks, as interest rates have limited influence on underlying supply issues.

Accordingly, most major central banks held rates steady at their latest meetings, emphasizing a wait-and-see, data-dependent approach. In the U.S., inflation remains somewhat above target, while job gains have slowed. In Canada, inflation has moved closer to target, and the economy is operating with more slack, allowing policymakers flexibility to monitor developments for future decisions.

Corporate Fundamentals: Still Constructive

Earnings estimates remain optimistic. Major equity markets, including Canada and the U.S., entered the year with expected profit growth in the mid-teens. Although analysts appear to be taking a similar “wait-and-see” approach as central banks, full-year forecasts have nonetheless trended higher in recent weeks, suggesting continued confidence in economic fundamentals despite a widening range of potential outcomes. As expectations remain elevated, strong earnings delivery will likely be crucial to providing fundamental support for equity markets.

Takeaway

Recent market swings have been driven largely by the Iran conflict and rising oil prices, raising concerns that higher energy costs could dampen growth while adding to near-term inflation pressures. While the corporate earnings outlook remains favourable, markets will need greater confidence in a path toward de-escalation before sentiment can improve more sustainably.

For investors, periods like this can feel uncomfortable but can also present opportunities to add quality assets at more attractive valuations. Despite elevated cross-asset volatility, long-term financial plans and diversified portfolios are built to endure a range of market environments. When uncertainty dominates headlines, maintaining discipline and perspective becomes especially important.