When energy prices spike for geopolitical reasons no central bank can control, and interest rates rise at the same time to cool an inflation that partly stems from that same energy shock, the risk is no longer just inflation or just recession — it’s something worse: both at once.
When the two phenomena overlap, persistent inflation and slowing economic growth, neither of the usual hedges works fully, because the central bank can’t cut rates to stimulate the economy without risking reigniting prices.
The unsolvable knot of monetary policy
Stagflation would historically be the most hostile scenario for anyone managing a portfolio, and the reason is structural. In a classic recession, central banks lower the cost of money, bonds rally, and they play their protective role. When inflation is the main problem instead, commodities and real assets offer an effective shield against the erosion of purchasing power. But in periods when the two phenomena coexist, that defensive architecture breaks down: cutting rates to support growth would only fuel prices further, while keeping them high, or raising them again, would further squeeze an economy that’s already struggling.
This is exactly the dilemma the Fed under Kevin Warsh would appear to be grappling with right now. Core inflation as measured by the Personal Consumption Expenditures (PCE) price index, the gauge the Federal Reserve uses as its primary reference for price pressures net of the most volatile components, would stand at 3.3% year-over-year, a level still far from the 2% target and one that doesn’t allow the central bank to ease up. Yet much of that inflationary pressure wouldn’t be domestic in origin: it would stem from the oil shock triggered by the widening conflict in the Middle East.
The supply shock that changes everything
WTI crude would have climbed back above $100 a barrel following the shutdown of the Saudi East-West pipeline, an artery that carried roughly 5 million barrels a day. The Houthis would control the Bab el-Mandeb strait (the passage between the Red Sea and the Gulf of Aden), through which 12% of global trade passes, and Saudi production would be at its lowest in three decades. Faced with a supply shock of this size, the interest-rate tool would be fundamentally inadequate: raising the cost of money doesn’t reopen the wells, doesn’t restore shipping routes, and doesn’t reduce the energy-bill burden on households and businesses. The only effect would be to squeeze domestic demand, adding deflationary pressure to a real economy that’s already exposed on multiple fronts.
The Federal Open Market Committee’s (FOMC) unanimous vote in favor of its latest 25-basis-point hike would appear to signal a more pronounced hawkish convergence within the committee compared with the July meeting, when three members had voted against it. The “dot plot,” the Fed’s quarterly map of rate projections, would point to at least one more hike before the end of 2026 and a plateau through 2027. The market, however, may already be pricing in a more aggressive scenario, and that gap between the expectations implied by prices and the official forward guidance could translate into significant bouts of volatility over the coming quarters.
How to build a defense in a stagflationary scenario
Protecting a portfolio in a setting like this would require thinking on several levels at once. TIPS, or Treasury Inflation-Protected Securities, would offer direct protection against the inflationary leg of the scenario, adjusting principal in line with consumer prices. Long-duration Treasurys, such as those tracked by the TLT ETF, could instead play an asymmetric role if a recession were confirmed: if growth weakened enough to force the Fed to reverse course, long bonds could appreciate significantly just as the equity portion of a portfolio suffers. For European investors, Italian BTPs (Buoni del Tesoro Poliennali, Italy’s benchmark long-term government bonds) would offer an alternative worth watching closely, given that their yield spread over German Bunds (Germany’s own benchmark government bonds) could widen in a global risk-off phase, though the euro-area anchor remains a source of stability relative to currency swings.
XAU/USD, gold priced in dollars, and energy commodities more broadly would tend to perform well during the acute phase of inflation, but could give back ground if the scenario degenerated into a deeper global recession, one in which commodity demand collapses.
The bottom line
Stagflation isn’t a certain or inevitable scenario, and it would be misleading to present it as one. A diplomatic solution that brings oil back toward $70 could emerge, the Fed could succeed in cooling inflation without derailing growth, and markets could find a new equilibrium faster than many analysts imagine today. But the question worth asking isn’t whether the scenario will play out with certainty, it’s whether your portfolio would be able to hold up if it moved even partway there.
Investors with a heavy concentration in equities, little available liquidity, and no protection against inflation could find themselves having to make hard decisions at the worst possible moment, under emotional pressure. Thinking through scenarios today that we hope won’t materialize would seem to be the clearest-headed way to approach a landscape that, for the first time in many years, has more variables simultaneously out of control.
Editor’s note
This article was originally published in Italian on money.it by Tommaso Scarpellini on September 20, 2026 as «Come proteggersi dalla stagflazione, il (possibile) scenario peggiore del 2027». It has been translated and adapted for an international audience by the Money.it International desk.
