When the Trade-offs Return

Recent data suggest that the impact of the Gulf region conflict is beginning to extend beyond energy markets and into the broader economy. Preliminary March activity indicators show that growth across major economies remains in expansionary territory, but has slowed, with the G4 output index easing to 51.2 from 52.2 in February. At the same time, inflation pressures are beginning to rebuild, reflecting the early effects of supply disruptions and higher energy costs. 

This creates a more complex backdrop than earlier in the year. It is no longer simply a question of whether growth holds, but whether it can do so while cost pressures rise again. The interaction between moderating activity and firmer inflation is what makes this phase more complex.

ASEAN+3 is Exposed But Better Positioned

The implications are particularly relevant for the ASEAN+3 region, which includes Southeast Asia, China, Japan and South Korea, where reliance on imported energy remains significant. A large share of oil and gas imports into the region originates from the Middle East, making it directly exposed to disruptions in supply and higher prices. These effects feed quickly into production costs, inflation and external balances, particularly for economies with large manufacturing bases.

At the same time, the region enters this phase from a position of relative strength. Growth has remained resilient, expanding by around 4.3% in 2025, while inflation averaged just 0.9%, providing a degree of buffer against external shocks. This starting point matters, as it allows policymakers more room to absorb supply-driven price increases without immediately tightening policy.

There are also important structural differences across the ASEAN+3 region compared to previous energy shocks. These economies are less energy-intensive than in the past, power generation has become more diversified, and early progress in electrification is beginning to reduce reliance on fossil fuels in certain sectors. These changes do not eliminate vulnerability, but they do make the region less sensitive to oil price movements than it was in earlier cycles.

Trade is Shifting Rather than Contracting

Another notable feature of the current environment is how global trade has responded. Despite rising geopolitical tensions and changes in trade policy, global trade flows have remained intact. Rather than contracting, they have shifted across regions, with demand being redirected towards Southeast Asia and India as trade patterns adjust. 

This reflects a broader reconfiguration of supply chains. Instead of reversing globalisation, current conditions are encouraging diversification, with production and trade becoming more distributed across multiple regions. The result is a system that is less dependent on any single trade corridor, but arguably more complex to navigate.

For Asia, this creates a dual dynamic. Greater participation in global trade supports growth, but also increases exposure to external shocks, particularly through energy prices and intermediate inputs.

Markets are Beginning to Adjust

Financial markets are starting to reflect these developments, although the adjustment remains incomplete. Equity markets have shown signs of weakness, but remain relatively elevated, suggesting that expectations for growth have not yet been materially revised. At the same time, bond yields have moved higher, indicating that inflation risks are being reassessed rather than dismissed. 

This combination points to a market that is recognising the change in conditions, but has not fully incorporated the implications of sustained energy prices. Positioning data reinforce this view. Flows into equities remain broadly supportive, credit spreads have widened but are still contained, and volatility, while higher, remains below levels typically associated with more pronounced stress. 

The picture that emerges is one of gradual adjustment rather than abrupt repricing. Markets are moving, but not decisively.

Policy Becomes Less Straightforward

Higher energy prices introduce a more difficult policy environment. An increase in oil prices tends to push inflation higher while at the same time weighing on growth. Estimates suggest that a sustained rise in energy prices could lift inflation by around 0.7 percentage points while reducing growth by approximately 0.2 percentage points. 

This creates a tension for policymakers. The case for easing becomes less clear if inflation proves persistent, yet weaker growth limits the scope for tightening. As a result, policy is likely to become more cautious and more dependent on incoming data, rather than following a clear directional path.

This shift matters because markets had entered the year expecting a relatively straightforward easing cycle. That assumption is now being tested.

Positioning Reflects Incomplete Adjustment

The broader shift is not confined to any single asset class, but to how the overall environment is being interpreted. An energy shock of uncertain duration, combined with moderating activity and rebuilding inflation pressures, creates a setting in which risks are more evenly balanced.

Markets, however, still appear to be treating this as a contained episode. Positioning suggests that the implications have not been fully absorbed, with flows continuing into risk assets and pricing yet to reflect a significant change in the macro backdrop. 

This leaves room for further adjustment should current conditions persist, particularly if inflation proves more durable than expected.

Adjustment is Still Unfolding

The latest data do not point to an immediate downturn, but they do indicate a shift in the underlying dynamics. Growth remains positive, though moderating, while inflation pressures are beginning to rebuild, particularly through energy. Supply disruptions are becoming more visible in production and pricing, reinforcing the link between geopolitics and the real economy.

What stands out is how these forces are coming together. Growth is slowing, while inflation pressures are re-emerging, creating a more complex environment than earlier in the year.

Markets, for now, appear to be treating these developments as manageable. However, experience suggests that when these dynamics occur together, the effects tend to build gradually before becoming more visible.

The process, in other words, is still unfolding.