Galaxy Strategy: Energy Shock Is Only the Beginning; U.S. Debt Faces a Severe Test

Key Takeaways

Escalation in the Iran–U.S. conflict continues, with military strikes and diplomatic maneuvering happening in parallel. Iran restricts navigation through the Strait of Hormuz and continues to carry out “True Promise-4” operations, launching multiple rounds of attacks on U.S. and Israeli targets; meanwhile, the U.S. and Israel expand airstrikes against Iran’s military and infrastructure. U.S. President Trump has made repeated tough statements, saying that military actions have achieved “decisive victory,” and warning that if negotiations fail, the U.S. will strike Iran’s energy facilities, while also proposing reopening the Strait of Hormuz as a ceasefire condition. During this period, battle-damage incidents such as U.S. Air Force aircraft being shot down also appeared, and the risk of the conflict spilling over extended to the Gulf region and multiple Middle Eastern countries; overall, the situation still remains in a standoff phase.

The core drivers of global market volatility this week still come from the Middle East geopolitical conflict and energy shocks. Iran’s fighting remains locked in a stalemate, and disruptions to Strait of Hormuz passage are ongoing. Concerns about a possible interruption to global oil supply have pushed WTI crude oil prices to new highs, and have also lifted energy and some industrial commodities overall, while raising potential inflation expectations. Against this backdrop, precious metals and some industrial metals have moved higher in sync. At the same time, energy shocks combined with uncertainty about inflation make major central banks remain cautious about shifting policy. U.S. Federal Reserve officials have generally signaled that they will keep interest rates unchanged, but U.S. Treasury yields have fallen overall. In equities, U.S. nonfarm payroll employment came in clearly better than expected, and active capital operations in the technology sector provided support to market sentiment, enabling European and U.S. stock markets to rebound after midweek volatility. By contrast, China’s equity market performed relatively weaker, affected by adjustments in growth sectors and a pullback in risk appetite.

The 1970s oil crisis shows that when energy prices rise sharply and policy responses are hesitant, supply shocks can easily evolve into stagflation. At the time, OPEC production cuts led oil prices to rise by roughly four times in the short term. During the chairmanship of Arthur Burns, the Fed viewed the oil price rise as a non-monetary shock and did not tighten policy in time, ultimately pushing inflation expectations off anchor and forming a wage–price spiral. Only after Paul Volcker implemented extreme tightening measures was inflation brought back under control, but the cost was a severe recession. Compared with the 1970s, the current global economies have clearly lower energy intensity and more diversified supply sources. Meanwhile, artificial intelligence and automation technologies weaken workers’ bargaining power, thereby reducing the probability of a comprehensive wage–price spiral forming. However, at the same time, the current high level of public debt imposes new constraints on the macro policy environment.

An expansion in U.S. Treasury supply alongside weakening demand puts ongoing upward pressure on long-end interest rates. As of March, U.S. federal debt is approaching $4 trillion (about $400k), and the expansion pace has accelerated noticeably in recent months. Combined with increased overseas military spending and persistent long-term fiscal deficits, demand for issuing new debt remains rising. At current interest-rate levels, interest expense is growing relatively quickly, and in fiscal year 2026 it may exceed $1 trillion. The demand side is also changing: high inflation suppresses real returns, and major overseas holders such as Japan and China had already shown periodical reductions in their holdings of U.S. Treasuries by the end of 2025. At the same time, some Middle Eastern oil exporters and emerging markets are gradually pursuing reserve diversification, reducing reliance on a single asset. Against this backdrop, U.S. Treasuries can no longer reliably absorb global safe-haven capital the way they did in the past. Yields are more easily affected jointly by an increase in supply and inflation expectations, leaving the long-end yield term premium under upward pressure.

Under the backdrop of high oil prices, high inflation, and high interest rates, the global asset-pricing logic is changing. U.S. Treasury yields are more easily influenced by inflation and supply, and the long-end yield “central tendency” faces upward pressure. Gold has allocation value in an environment of inflation and uncertainty, and a rise in the oil price “central tendency” becomes an important constraint. The U.S. dollar is still supported in the short term by safe-haven demand and liquidity, but in the medium term it faces adjustment pressure amid fiscal stress and reserve diversification. The attractiveness of RMB assets is likely to increase. As China stays away from the core areas of conflict and policy still has room, along with strong industrial chains and supply capacity, it has advantages in the “stability” dimension.

Risk Warning

Geopolitical disturbance risk; risk of uncertainty in Trump’s policies; risk that overseas rate cuts fall short of expectations; risk that the domestic policy implementation effects fail to transmit as expected.

Main Text

I. Tracking Developments in the Iran–U.S. Conflict

From March 30, 2026 to April 5, the U.S. and Iran are still repeatedly locked in tug-of-war between military pressure and diplomatic probing, with no breakthrough progress in the short term that can change the course of the conflict. On March 30, Iran’s Parliament’s National Security Committee adopted a plan for managing the Strait of Hormuz, announcing that it would ban U.S. vessels and vessels from countries participating in unilateral sanctions against Iran from transiting the strait. On the same day, U.S. President Trump publicly stated that if an agreement cannot be reached through negotiations, the U.S. will destroy key energy infrastructure such as Iran’s power generation facilities and oil wells, as well as Halk Island located in the Persian Gulf, and emphasized that the U.S. will not allow Iran to obtain nuclear weapons. Meanwhile, Israel launched multiple rounds of airstrikes against Tehran, targeting about 40 weapon production and R&D facilities, further increasing the intensity of the conflict. On March 31, Iran initiated the 88th round of the “True Promise-4” operation, striking shipping targets in the Persian Gulf and continuing long-distance attacks on U.S. and Israeli military facilities. On the same day, U.S. President Trump said he hopes to end U.S. military operations against Iran “within two to three weeks,” and will use Pakistan to push for indirect negotiations with Iran. The U.S. military used 2,000-pound earth-penetrating munitions to strike a large ammunition depot in Isfahan, Iran. Israel’s military also announced that in the past 24 hours it had struck about 20 weapon production facilities inside Iran.

On April 1, Israel announced that in the past two days it had carried out airstrikes on about 400 targets inside Iran. Iran fired about 10 ballistic missiles at central Israel, launching the largest missile attack since the start of the war. On the same day, U.S. President Trump said U.S. forces might “soon” withdraw from Iran and proposed that if Iran reopens the Strait of Hormuz, the U.S. would be willing to push for ceasefire arrangements. Meanwhile, the U.S. military deployed 18 additional A-10 attack aircraft to the Middle East, doubling the scale of attack aircraft deployment in the region. On April 2, Iran carried out the 90th round of the “True Promise-4” operation, continuing to strike related U.S. and Israeli military and industrial targets. That day, Trump delivered a televised nationwide address, claiming that U.S. military operations against Iran have achieved “fast, decisive, overwhelming victory,” and said that if an agreement cannot be reached via negotiations, the U.S. will continue to carry out more intense strikes against Iran over the next two to three weeks, and may directly strike Iran’s energy facilities.

On April 3, an F-15 fighter jet of the U.S. Air Force was shot down over Iran. Two pilots parachuted out—one was rescued, and the other remains missing. Subsequently, two A-10 attack aircraft were attacked: one crashed into the Persian Gulf, and the other made an emergency landing. On the same day, Iran announced that in the 92nd round of the “True Promise-4” operation it had destroyed U.S. military radar systems and naval equipment. Israel continued to expand airstrikes on Tehran and surrounding military targets. On April 4, Iran launched the 95th round of the “True Promise-4” operation and said that its air defense system hit an A-10 attack aircraft of the U.S. near the Strait of Hormuz, while also claiming it shot down an F-35 fighter and multiple unmanned drones. That day, the Bushehr nuclear power plant in Iran was hit again, raising regional concerns about nuclear safety risks. Meanwhile, signs of spillover from the conflict became further apparent: some cities in Iraq’s border port areas and in the Gulf region were affected.

II. Performance of Major Asset Classes Within the Week

The core driver of global market volatility this week still comes from the Middle East geopolitical conflict and energy shocks. Iran’s fighting remains stuck, and passage through the Strait of Hormuz is disrupted, driving a clear increase in market concerns about a potential interruption to global oil supply. This pushed WTI crude oil prices to new highs and lifted energy and some resource commodities overall, while also raising potential inflation expectations. Against this backdrop, precious metals and some industrial metals moved higher in sync. At the same time, energy shocks combined with uncertainty about inflation make major central banks remain cautious about shifting policy. U.S. Federal Reserve officials have generally signaled that they will keep interest rates unchanged, but U.S. Treasury yields have fallen overall. In equities, U.S. nonfarm payroll employment was clearly better than expected, and active technology-sector capital operations supported market sentiment, enabling European and U.S. stock markets to rebound after midweek volatility. Meanwhile, China’s equity market was relatively weaker, affected by adjustments in growth sectors and a decline in risk appetite.

Specifically, NYMEX WTI crude oil rose 12.46%, LME aluminum rose 5.26%, COMEX silver rose 4.83%, LME zinc rose 4.80%, the UK FTSE 100 rose 4.70%, the Nasdaq index rose 4.44%, COMEX gold rose 3.95%, Germany’s DAX rose 3.89%, the Eurozone STOXX rose 3.77%, ICE Brent crude rose 3.72%, France’s CAC40 rose 3.38%, the S&P 500 rose 3.36%, the Dow Jones Industrial Average rose 2.96%, LME copper rose 1.35%, the FTSE Singapore Strait Index rose 1.01%, the Ho Chi Minh Index rose 0.67%, the Hang Seng Index rose 0.66%, the pound sterling to U.S. dollar exchange rate rose 0.31%, CBOT soybeans rose 0.30%, the euro to U.S. dollar exchange rate rose 0.06%, the U.S. Dollar Index rose 0.02%, India’s SENSEX30 fell 0.36%, the U.S. dollar to the Japanese yen exchange rate fell 0.38%, the Nikkei 225 fell 0.47%, the U.S. dollar to offshore RMB fell 0.48%, SHFE rebar fell 0.77%, the SSE Composite Index fell 0.86%, the 10-year China government bond yield fell 1 BP, CBOT wheat fell 1.20%, DCE iron ore fell 1.60%, CBOT corn fell 2.16%, the SZSE Component Index fell 2.96%, the ChiNext Index fell 4.44%, NYMEX natural gas fell 7.21%, and the 10-year U.S. Treasury yield fell 11 BPs.

III. Comparing This Round of the Energy Crisis With the 1970s: Similarities and Differences

The current Iran–U.S. conflict continues to escalate, and combined with rising risks to shipping through the Strait of Hormuz, global energy markets have entered a highly sensitive phase. On March 23, the International Energy Agency noted that the potential scale of the energy supply shock this time could exceed the sum of the two oil crises in the 1970s. Based on historical experience, energy supply shocks are not only a matter of commodity price volatility; they are more likely to become an important turning point in the macro cycle. The first oil crisis in the 1970s occurred after the fourth Middle East war in 1973. OPEC’s Arab member countries applied energy pressure to Western countries through production cuts and embargoes. International oil prices rose by about four times in a short period, and global energy costs jumped sharply. At the time, Fed Chair Burns believed that the oil price rise was a supply shock, not a monetary factor, so there was no need for strong intervention through monetary policy. He judged that the rise in energy prices would gradually ease through supply adjustments and substitution effects. However, this assessment ignored the “second-round effects” of supply shocks. As energy prices rise, companies’ production costs clearly increase; workers demand higher wages to offset the rise in living costs. Companies then pass the costs on to consumers, forming a feedback loop that pushes wages and prices up against each other, and inflation expectations gradually come unmoored. By 1974, the U.S. inflation rate had already climbed to double digits, while economic growth slowed markedly, and a stagflation pattern began to form.

At the time, U.S. President Nixon and his administration continued to pressure the Fed, hoping to maintain low interest rates to support economic growth, which meant monetary policy did not tighten in time during a critical stage. Similar political interference has also been used in the current context. U.S. President Trump has repeatedly and publicly criticized Fed Chair Powell’s policy stance. Historical experience shows that when energy supply shocks coincide with policy hesitation, inflation is more likely to spiral out of control. Ultimately, the U.S. only managed to stabilize inflation expectations again after Paul Volcker became Fed chair in 1979, and did so through extremely aggressive rate hikes, but the cost was a severe economic downturn. In a stagflation environment, traditional asset-allocation structures often face a risk of failure. Due to high inflation pushing up the interest-rate level, bond prices fell sharply; meanwhile, slowing economic growth suppressed corporate earnings, putting stock markets under pressure as well. Not until inflation was controlled in the Volcker era did the long-term bond market begin a sustained bull market lasting for decades. Therefore, historical experience indicates that when an energy supply shock evolves into a stagflation environment, traditional stock–bond allocations often cannot provide effective hedging.

However, compared with the 1970s, today’s global economic structure also has clear differences. First, energy intensity in developed economies has fallen significantly. Over the past 50 years, technological progress and changes in industrial structure have greatly reduced energy consumption required per unit of GDP, meaning that the impact of oil price increases on economic growth is relatively weaker than in the 1970s. Second, the global energy supply structure is more diversified: the shale oil revolution in the U.S. has significantly increased production capacity in non-OPEC countries, greatly enhancing supply elasticity in the global oil market. In addition, the structure of the labor market has changed. In the 1970s, Western countries had stronger labor unions, and rising energy prices could be quickly transmitted to companies’ costs through wage negotiations, further forming a wage–price inflation spiral. But under today’s economic structure, contemporary technologies replacing labor and digital production methods to some extent suppress the persistence of wage growth, thereby lowering the probability of a comprehensive wage–price spiral forming.

IV. Where should U.S. Treasuries go as they approach the $4 trillion scale?

Despite these structural differences, the current macro environment also has new risk factors. The global level of public debt is clearly higher than in past periods, and the fiscal burden from rising interest rates has become significantly heavier. Central banks face more complex constraints when responding to energy shocks. As of March 2026, total U.S. federal government debt has already exceeded $3.9 trillion, rising from $3.8 trillion to $3.9 trillion in only 5 months—such a growth pace is not common in non-war, non-systemic-crisis “normal” environments. Behind the rapid debt expansion, on the one hand there are structural pressures from long-term fiscal deficits and tax-cut policies; on the other hand there are additional expenditures stemming from recent geopolitical conflicts. For military actions related to Iran, direct spending has already exceeded $12 billion, and the government is still applying for more than $200 billion in follow-on budget arrangements, further increasing the scale of the fiscal deficit.

More troublesome than the debt scale is the snowball effect of interest expense. Based on current interest-rate levels, in fiscal year 2026 the United States’ federal net interest outlays are expected to exceed $1 trillion, a scale already larger than defense spending in the same period. Currently, the U.S. debt-to-GDP ratio has risen to a high level of 120%. The longer the high interest-rate environment lasts, the easier it is for debt expansion and interest outlays to fall into a cycle of issuing new debt to pay interest and then issuing more debt. The test of fiscal sustainability will only grow more severe. At the same time, uncertainty is also hidden on the demand side for U.S. Treasuries. High inflation keeps eroding the real return on Treasuries, and their traditional safe-haven role is weakening at the margin. In terms of foreign holdings, by the end of 2025, Japan, the UK, and China—the three major holders—had reduced their holdings of U.S. Treasuries in sync, reflecting structural concerns by overseas capital about the U.S. fiscal path. The trend of de-dollarization and reserve diversification is still ongoing. If overseas demand weakens at the margin, U.S. Treasury yields will rise further and financing pressure will intensify accordingly.

Under the transmission chain of high oil prices, high inflation, and high interest rates, Treasury risk has shifted from being purely a question of scale to a deeper structural issue. In the short term, U.S. Treasury yields will likely remain in a high-range sideways-to-volatile pattern. Fiscal pressure and market volatility may form reinforcing effects. In the medium term, U.S. policy room has been greatly narrowed: either shrink fiscal spending to cut the deficit, or in extreme cases rely on monetary-funding to absorb debt. Both paths come with significant costs and constraints.

Against this backdrop, we reviewed how the U.S. Treasury issuance scale has evolved across past periods of wars and geopolitical conflicts, aiming to answer whether this debt-to-respond-to-debt mode is approaching a turning point. It can be found that the impact of wars on U.S. Treasuries is not linear; it is more like an amplifier rather than a decisive variable. In most periods, it is not a single war expenditure that truly drives a jump in debt scale; instead, it is the macro cycle on top of it and institutional restructuring. Take the late stage of the Vietnam War as an example: growth in the stock of U.S. Treasuries was relatively moderate; the issuance of new Treasuries served the dual expansion of welfare and military expenditures, and the war provided “legitimacy” for deficit expansion. But what truly elevated the debt path was the rebuilding of the U.S. dollar credit system after the collapse of the Bretton Woods system. Similarly, during the Afghanistan and Iraq war stages, net issuance of U.S. Treasuries increased sharply multiple times, but the core drivers were also not limited to military consumption; more crucially, they were the countercyclical policy expansions in response to the subprime crisis.

From a yield-pricing perspective, wars themselves do not directly determine the direction of interest rates; the key remains the credit anchor and the monetary policy framework. During the Vietnam War era, U.S. Treasury yields rose sharply not because of supply expansion, but because the U.S. dollar credit system wavered, leading to inflation getting out of control. The outflow of gold and the loss of the dollar anchor jointly pushed nominal rates higher; the war mainly played the role of an inflation catalyst. By contrast, the Reagan-era experience is more comparable: the 1980s military buildup doubled the stock of U.S. Treasuries quickly, but under Volcker’s forceful rate hikes and with inflation expectations re-anchored, the 10-year U.S. Treasury yield fell—from around 15% down to about 8%. What this reflects is the dominant role of monetary policy credibility in yield pricing, as the “oil–dollar–U.S. Treasuries” loop gradually took shape. Surplus flows from global oil-producing countries returned to the U.S., providing stable funding sources and enabling the U.S. to carry larger-scale fiscal expansion.

Looking further, in a rate-cut cycle, war tends to strengthen rather than weaken the demand-side support for U.S. Treasuries. During the Gulf War, U.S. fiscal pressure was relatively controllable: multiple countries shared costs. At the same time, the global economy was in a period of downside pressure and policy easing, and safe-haven capital inflows combined with the rate-cut environment effectively offset the upward pressure from increased Treasury supply. After entering the 21st century, this mechanism was further reinforced. In the anti-terrorism war phase, the scale of U.S. Treasuries expanded significantly; however, because the Fed maintained zero interest rates for a long time and implemented quantitative easing, and directly purchased Treasuries to suppress long-end yields, the traditional constraint relationship between issuance scale and yields was substantially weakened.

After the Russia–Ukraine conflict in 2022, supply shocks combined with demand repair pushed the world into a high-inflation phase. The Fed was forced to rapidly raise rates, and U.S. Treasury yields rose one-directionally. In this stage, on the one hand, the U.S. supported overseas military and fiscal spending by increasing Treasury issuance; on the other hand, it faced rising rolling costs driven by the rapid rise in rates. Interest expense pressure quickly amplified, even to the point where the net issuance scale surpassed $1 trillion within a single quarter. Because inflation exhibited a wage–price spiral feature that reinforces itself, the reaction of rates to inflation falling lagged, causing yields to remain at high levels for a longer period of time.

It is also precisely in this historical comparison that the special nature of the current environment begins to become apparent. Unlike in the past, this conflict is combined with a constraint package of high oil prices, high inflation, and high interest rates. This may imply that among the scale of Treasury issuance, financing costs, and market demand, they could once again enter a “directional tightening” state. As a result, the traditional “respond with debt” model may face even higher constraints.

V. How do major asset classes change under the narrative of re-accelerating inflation?

Under the current macro environment, the core logic of global asset pricing is shifting toward a structural framework of multiple constraints layered together. High energy costs, inflation persistence, and policy uncertainty jointly form the new underlying basis for pricing. Even if there is no extreme supply interruption, as long as energy prices remain in a high range, the inflation path and the long-term interest-rate “central tendency” will be systematically lifted, and global assets will gradually adapt to a new normal of “high costs + high interest rates + high volatility.”

In past geopolitical conflicts, markets typically followed a path of “risk rises—capital flows into U.S. Treasuries—yields fall,” benefiting clearly because U.S. Treasuries are the core safe-haven asset. But this time, the operating mechanism has already changed. The leading logic is no longer safe-haven sentiment; it is inflation and interest-rate constraints. After oil prices quickly rose to above $100, the market first adjusted inflation expectations and the path of monetary policy, rather than simply increasing safe-haven demand. In a backdrop where rate-cut expectations are compressed and even rate hikes are being discussed again, U.S. Treasury yields instead rose, reflecting the characteristic that the “inflation shock overwhelms safe-haven demand.” At the same time, U.S. federal debt is approaching $4 trillion. At current interest-rate levels, interest expense is rising quickly, and dependence on issuing new debt continues to deepen. With supply-side expansion combined with a high-inflation environment, it is easier for long-end yields to be driven by the dual factors of “more issuance and higher inflation expectations,” making it difficult for them to be suppressed the way they were in the past by safe-haven capital. Under this framework, the pricing logic for U.S. Treasuries is shifting from “safe-haven dominant” to “inflation and supply dominant.” The result is that the yield curve faces renewed pressure to steepen again, and the long-end yield “central tendency” tends to be easier to push up than down. The safe-haven attribute of long-term government bonds weakens at the margin. By contrast, the benefit logic for gold is more direct: when inflation persistence, uncertainty about real interest rates, and credit concerns coexist, gold carries both safe-haven and currency-substitution characteristics, making it more likely to receive sustained allocation demand.

If the conflict becomes prolonged but the shipping lanes maintain nominal through-traffic, the typical behavior of the oil market would not be “price hikes from a supply-cut style,” but a systematic rise in the risk-premium “central tendency.” Ship insurance, escort costs, detours, and supply-chain buffer inventories will all raise marginal costs. The oil price “central tendency” would most likely move higher and stay with high volatility. Further, this kind of shock would reshape global energy trade routes: Europe and Asia would be more proactive in seeking alternative sources outside the Middle East. The strategic value of U.S. shale oil, Russian crude, and other regional supplies would rise, but in the short term global spare capacity is limited and cannot fully replace the hub role of the Strait of Hormuz. Therefore, high oil prices are more likely to become a phase of normality rather than a short-term spike. Under this scenario, the core mainline for commodities would shift from “demand cycles” to “supply security.”

Changes in the FX market would be even more complex, and the U.S. dollar may show a “strong-short, weak-long” pattern. In the short term, liquidity advantages and safe-haven demand still support the dollar. But as fiscal constraints worsen and inflation pressures rise, the market’s reassessment of U.S. dollar credit will gradually unfold. Structurally, the dollar’s share in global reserves has already fallen clearly from historical highs, and the trend toward reserve diversification continues to advance. With energy and payment security being emphasized at the same time, the use of non-dollar currencies in cross-border settlement may increase at the margin. Currencies with support from trade and industry—such as the RMB—would have more potential upside space.

In equities, the degree of global market divergence may be further reinforced. The combination of high oil prices and high interest rates suppresses the valuation “central tendency,” especially in markets that depend on a low-interest-rate environment. U.S. equity assets may gradually move from the past phase of high-valuation expansion into a new stage characterized by high volatility, low returns, and more severe structural divergence. By contrast, markets with advantages in complete industrial chains and supply capacity may instead receive relatively stronger support under the logic of energy security and industrial restructuring. Hong Kong stocks may experience higher volatility influenced by foreign capital flows, but when valuations are at a low level, their attractiveness to long-term capital is expected to improve.

At bottom, today’s asset-pricing system is undergoing a restructuring of underlying logic. The core is no longer just growth and interest rates, but the balance among energy costs, fiscal constraints, and monetary credit. In this process, the traditional definition of “risk-free assets” may loosen. Gold, energy, and some assets with characteristics of supply security and credit stability will gradually gain new sources of premium.

VI. Risk Warning

Geopolitical disturbance risk; risk of uncertainty in Trump’s policies; risk that overseas rate cuts fall short of expectations; risk that the domestic policy implementation effects fail to transmit as expected.

(Source: Galaxy Securities)