UBS: If Middle East Conflict Persists for Months, Global Economy May Face Deep Recession, S&P 500 Falls to 5350 Points

The escalating Middle East conflict is pushing global energy markets to a tipping point, with macroeconomic consequences that could far exceed current market pricing. UBS warns that if the crisis extends into the second half of this year, most major global economies will face the risk of recession, and the S&P 500 index could fall significantly from current levels to 5350 points.

According to the "Chasing Wind Trading Desk," UBS released its global economic and strategy report on March 26. The conflict is now in its fourth week, with ten countries directly involved. The blockage of the Strait of Hormuz has disrupted approximately 20% of global oil and gas traffic. Global oil inventories are being depleted at a rate of about 9 million barrels per day and are expected to reach historical lows as early as the end of April.

UBS points out that current market pricing still reflects expectations of a "quick resolution to the conflict"—credit spreads are narrowing, earnings forecasts have barely been revised downwards, and global stock ETF funds continue to flow in—an optimistic pricing that is clearly diverging from the actual pressures in the energy market.

Once the crisis is prolonged, the cumulative effect of the energy shock and tightening financial conditions will trigger highly non-linear economic downside risks, posing a significant challenge to global investors.

Three Scenarios: From Brief Disruption to Deep Recession

UBS has outlined three pathways.

Scenario 1 (Five-Week Disruption): The conflict is resolved in early April, Brent crude oil prices briefly surge to $120/barrel before retreating, with limited macroeconomic impact. The S&P 500 index is expected to rebound to 7150 points by year-end.

Scenario 2 (Two-Month Disruption): Oil prices peak at $130/barrel, global growth declines by about 30 basis points compared to the baseline, and the S&P 500 index falls towards 6000 points in the second quarter before gradually recovering to approximately 6900 points by year-end.

Scenario 3 (Prolonged Disruption): The conflict continues until the end of the third quarter, Brent oil prices remain around $150/barrel for the entire year, global growth declines by nearly 100 basis points compared to the baseline, the S&P 500 index hits 5350 points in the second quarter, and substantial recovery is not expected until 2027.

The report emphasizes that the impact of oil price shocks is significantly non-linear. UBS models show that oil prices at $150/barrel are about three times more destructive to the economy than prices at $100/barrel; if the probability of recession increases by 20 percentage points, the impact can be five times greater.

Critical Inventory Levels: Non-Linear Upside Risk for Oil Prices Looms

The Strait of Hormuz remains nearly closed. UBS's energy team estimates that even considering the alternative pipeline transport capacity of Saudi Arabia and the UAE, Iran's remaining export volumes, and the release of strategic reserves, there is still a daily global supply deficit of about 9 million barrels. This deficit is currently being bridged only by rapidly depleting inventories.

At the current rate of depletion, global oil inventories are expected to fall into the bottom third of the historical range this week. If this trend continues, historical low levels could be reached before the end of April.

Historical experience shows that when inventories approach extremely low levels, oil prices often exhibit highly non-linear increases—buy orders for precautionary procurement can significantly amplify upward price momentum. UBS points out that in this scenario, Brent crude oil prices could move towards $150/barrel or even higher.

Furthermore, the secondary impact of fertilizer and food prices has not been fully incorporated into the model. This region supplies about 30% of global fertilizer exports. A significant increase in energy prices will be transmitted through fertilizer costs to global food prices. UBS estimates this could add an additional 50 basis points of inflationary pressure in developed economies and as much as 240 basis points in emerging markets.

Soaring Inflation, Diverging Central Bank Policy Paths

The impact of inflation is significant across all three scenarios. Even the mildest five-week disruption is enough to raise global inflation by about 50 basis points this year; in the two-month and prolonged disruption scenarios, this figure rises to approximately 90 basis points and 190 basis points, respectively.

UBS believes that central bank reactions will diverge significantly.

The European Central Bank, facing a tight labor market, a single inflation mandate, and policy rates already near neutral, is more inclined to raise rates than cut them in a mild shock scenario. Even in the prolonged disruption scenario, UBS expects the ECB to only slightly reverse previous rate hikes, showing a more conservative stance than the Federal Reserve.

Conversely, the Federal Reserve, with a labor market showing signs of stagnation and policy still in restrictive territory, and a new chairman who may be more cautious about raising rates when the economy weakens. UBS believes that in the prolonged disruption scenario, if the U.S. economy enters a recession, the federal funds rate could fall to the zero lower bound in the third quarter of 2027.

The Bank of England's situation is between the two but closer to the Fed's stance; the Swiss National Bank might reintroduce negative policy rates in the prolonged disruption scenario; the Bank of Japan is expected to conclude its tightening cycle with one final rate hike this year before following the Fed into easing.

Equity Markets: Asia and Europe Face the Heaviest Pressure, Defensive Sectors Relatively Favored

Prior to the conflict, markets were in a typical early-cycle rotation—shifting from large-cap to small-cap, from growth to value, and from the U.S. to global markets, with credit spreads at historically very low levels. The core premise of this positioning was a gentle growth-inflation combination, a premise that the oil price shock is directly eroding.

In the prolonged disruption scenario, the S&P 500 target is approximately 5350 points, corresponding to a compression of the 12-month forward P/E ratio from the current ~22x to ~18x. U.S. large-cap stocks will be more resilient than small-caps, European markets, and emerging markets, but absolute performance will also be under pressure.

As the Strait of Hormuz is a major energy transport route for Asia, Asian stock markets will be the most severely impacted. European markets will also be significantly weaker than the U.S. due to their exposure to natural gas.

Historically, the sectors most affected by oil supply shocks have been consistently the same: automobiles, consumer durables and apparel, financial services, and capital goods have been the weakest performers. If liquidity further tightens in the two-month scenario, U.S. high-yield bond spreads could widen to 600 basis points, exacerbating the downside in equity markets.

Fixed Income: Short-End Value Emerges, U.S. Long-End Yields to Rise Before Falling

UBS believes that fixed income is the asset class where investment value is emerging earliest. Short-term interest rates in all markets have been significantly repriced, reflecting market concerns about central banks potentially needing to raise rates to prevent inflation expectations from de-anchoring. However, UBS considers this scenario unlikely, expecting the inflationary shock to primarily affect headline inflation rather than core inflation.

In all scenarios, U.S. 10-year Treasury yields are expected to peak in the second quarter of 2026, synchronizing with 2-year yields. The yield curve will exhibit a bear flattening in the short term, but will significantly steepen into a bull market in the medium term. In the prolonged disruption scenario, U.S. 10-year yields could eventually fall to 2.50%, but this is a story for 2027.

German 10-year yields are expected to approach a high of around 3% in all scenarios. UBS recommends going long German bonds with a target of 2.75% and a stop-loss of 3.15%. UBS believes that the most attractive value is currently in the direction of short-term interest rates in Switzerland, the UK, the U.S., and India.

Dollar Strong in Short Term, Weakening in Medium Term; Gold Awaits Growth Scare Takeover

During the initial phase of volatility, the dollar will maintain its status as a primary safe-haven currency, showing particular strength relative to Asian emerging market currencies.

However, in the prolonged disruption scenario, as the Federal Reserve shifts to aggressive easing, the dollar will face a trend of depreciation from the second half of 2026 to 2027. EURUSD could fall to 1.10 before year-end, while the Japanese yen may come under pressure due to Japanese fiscal concerns and the BoJ's policy shift, with USDJPY potentially rising to 175.

Gold has recently been suppressed by rising real interest rates and a strengthening dollar, failing to perform its traditional safe-haven role. However, UBS expects that once growth fears outweigh inflation concerns and global yields begin to fall, gold prices will regain their upward momentum.

UBS recommends the $4000 to $4250 range as an entry point for gold from a medium-term perspective. Precious metals with stronger industrial characteristics, such as silver, platinum, and palladium, will face greater downside pressure in a scenario of economic slowdown.