The government is about to find out you can’t please the people and the bond markets
In the next phase of the Iran crisis, investors will demand fiscal discipline; electorates will demand intervention. In a supply-driven stagflationary environment, it may be impossible to satisfy both, says Helen Thomas
A severe physical supply shock is rippling through the global economy and unlike recent crises, this is not one policymakers can easily offset. Disruption in the Strait of Hormuz, compounded by infrastructure damage and logistical bottlenecks, is triggering a cascading shortage across energy, industrial inputs and transport.
The scale is difficult to overstate. There are an estimated 800 ships stranded in the Persian Gulf. Cargo degradation, rerouted tankers and mismatched infrastructure constraints are compounding the problem. Crucially, supply cannot simply be reallocated without consequence. Japan recently announced that by May it expects more than half of its oil imports to come from routes that do not include the Strait of Hormuz. But if they secure oil from Brazil or Nigeria, those barrels are diverted from existing buyers, tightening conditions elsewhere.
Meanwhile, attacks on key energy infrastructure means this is not a temporary logistical issue but a multi-year supply impairment. One fifth of global liquid natural gas (LNG) supply comes from Qatar and damage to the Ras Laffan LNG facility will take three to five years to restore. As with pandemic-era shortages or the freezing of trade finance during the financial crisis, the core problem is stark: if supply is not there, it cannot be conjured by policy.
The disruption is now feeding through global supply chains. Helium critical to semiconductor manufacturing has seen a substantial portion of supply constrained. Fertiliser inputs risk missing planting cycles, raising the prospect of materially weaker harvests later in the year.
Energy shortages are also beginning to impair distribution itself. Fuel scarcity is disrupting transport networks, while precautionary hoarding is exacerbating shortages. Aviation offers a clear example. Rising jet fuel prices and uncertain availability are forcing airlines to alter routes, carry excess fuel, or cancel capacity altogether. These defensive responses, rational at the individual level, worsen system-wide scarcity.
A supply-side cascade
The result is a classic supply-side cascade: disruption in one critical input propagates across multiple sectors, amplifying economic damage.
The immediate consequence is higher inflation. Producer price pressures are already emerging, with China recording positive PPI after a three and a half year period of deflation. Historically Chinese PPI has served as a leading indicator for global inflation trends.
More concerning for central banks is the shift in expectations. Surveys in both the UK and US have both shown sudden and sharp increases in near-term inflation expectations, reflecting the lingering memory of the 2022 energy shock. This persistence, or what economists call “hysteresis”, raises the risk that inflation becomes embedded even as growth slows.
This marks a structural shift. The post-financial crisis environment of disinflation and abundant supply is giving way to a world shaped by geopolitical fragmentation, supply chain reconfiguration and resource competition. A two to four per cent inflation regime increasingly looks like the new baseline rather than the zero to two per cent of the prior decade.
In a conventional downturn, weaker growth would pull down long-term yields even as central banks tighten policy. But this dynamic breaks down if fiscal credibility is in doubt.
Governments facing high deficits, rising borrowing costs and inflationary pressure may struggle to anchor long-term debt markets. The risk is a simultaneous rise in yields across the curve. This would not be a sign of growth optimism but of investor concern over fiscal sustainability.
For the UK in particular, this risk is acute. Planned gilt issuance remains elevated, while political constraints limit the scope for spending restraint. Any attempt at further fiscal support to offset rising living costs risks clashing directly with market discipline.
Rising sovereign risk premia are already feeding through asset markets. Sectors predicated on low rates and abundant energy such as technology and AI infrastructure look increasingly exposed. These business models rely on cheap capital and stable input costs, both of which are now in question.
Stress is also emerging in private markets. Redemption limits at major private credit funds point to tightening liquidity conditions, while isolated losses in bank exposures suggest vulnerabilities may be surfacing.
Volatility indicators reflect this shift. As a rough rule of thumb, when the VIX is above 25, markets tend to reprice rapidly as previously ignored risks are incorporated. The recent sharp moves in traditionally defensive assets underline how fragile positioning has become.
Unlike previous market dislocations, this is not purely an economic story. The supply shock sits within a broader geopolitical realignment, with major powers actively reshaping trade flows and economic alliances. As US Treasury Secretary Scott Bessent put it in the very first sentence of his op-ed for The Economist in October 2024, “The United States must play a more active role in reshaping the international economic order”.
This tension is most visible in the UK. Weak growth, high energy costs and a constrained fiscal position leave little room for manoeuvre
This reduces the incentive for rapid de-escalation. Even if physical disruptions ease, the underlying fragmentation of the global economy is likely to persist, embedding higher costs and lower efficiency into the system.
For governments, the challenge is acute. Voters will demand relief from rising prices and potential shortages, yet policy tools are limited. Monetary easing risks entrenching inflation, while fiscal expansion may trigger market backlash.
This tension is most visible in the UK. Weak growth, high energy costs and a constrained fiscal position leave little room for manoeuvre. Political divisions further complicate the response, raising the risk of policy inconsistency at a time when credibility is paramount.
Targeted support may offer a partial solution but risks exacerbating broader dissatisfaction if perceived as uneven. If restricted only to those on benefits, the public might heed the argument by the new Green MP for Gorton & Denton, Hannah Spencer, who said in her victory speech “working hard, what does that get you?”.
More fundamentally, governments may be forced into difficult trade-offs between market stability and political pressure. The result is a potential confrontation between bond markets and elected governments. Investors will demand fiscal discipline; electorates will demand intervention. In a supply-driven stagflationary environment, it may be impossible to satisfy both.
That tension and the speed at which it escalates will define the next phase of the crisis.
Helen Thomas is founder and CEO of Blonde Money