The supply disruptions caused by the ongoing conflict in Iran and the Middle East are adding to inflationary pressures that were already bubbling under the surface.

This is according to strategists at the BlackRock Investment Institute (BII), who warned that central banks will face a difficult choice between reigning in inflation and supporting growth and jobs.

“We think higher yields are here to stay – and that long-term government bonds are no longer effective diversifiers against equity declines,” the strategists said in a recent note.

The BII is therefore keeping their underweight call to long-term government bonds, given the fact they struggled to offset equity declines throughout the Iran war.

“This is a structural feature of the post-pandemic environment as the term premium – the extra compensation investors demand for holding long-term bonds – rises on concerns over high debt loads,” the strategists said.

“We prefer short-dated credit and Treasuries for quality income instead, and EM hard-currency debt as it leans toward commodity exporters benefiting from supply disruptions.”

The BII also has reiterated an overweight call for US and emerging market (EM) equities on the back of the rapid artificial intelligence (AI) buildout.

“We are overweight U.S. and EM equities as major AI firms are now showing they can monetize their tools,” the strategists said.

They added: “We favor infrastructure and equipment supporting the AI buildout such as semiconductors, power and data centers.”

“We think they stand to benefit no matter AI’s eventual winners or losers. We see the AI boom lifting U.S. corporate earnings. underpinning our U.S. equity overweight.”

In emerging markets, they prefer commodity exporters and AI beneficiaries, as well as India, because “it sits at the intersection of megaforces”.