European stocks and U.S. equity futures edged higher on Wednesday, clawing back some losses from the previous session, but the recovery masked growing anxiety across global markets as investors confronted the mounting economic costs of the U.S.-Israeli war with Iran.

The rebound in equities came after a bruising selloff triggered by fresh U.S. inflation data showing consumer prices rose at their fastest pace in three years, largely driven by surging energy costs tied to the Middle East conflict.

While stock markets attempted to stabilize, bond markets painted a far more cautious picture. Government borrowing costs remained elevated across major economies as investors increasingly concluded that central banks may be forced to keep interest rates higher for longer, or even tighten policy further, if oil-driven inflation continues to intensify.

The divergence between equities and bonds underscores the unusual market environment now taking shape globally: investors are still willing to buy stocks, particularly technology and energy-linked companies, but are simultaneously bracing for slower growth, sticky inflation, and prolonged geopolitical instability.

Europe’s STOXX Europe 600 rose 0.3% by midday trading, while futures tied to major U.S. indexes pointed to a firmer Wall Street open, with Nasdaq futures up roughly 0.7%. London’s FTSE 100 was little changed.

Yet beneath the surface, markets remain deeply unsettled. The benchmark U.S. 10-year Treasury yield hovered around 4.46% after touching its highest level since March, while Japanese government bond yields surged to record highs in parts of the curve overnight.

The moves indicate investors are rapidly repricing inflation and interest-rate expectations globally. The market’s core concern is increasingly straightforward: the Iran conflict is no longer viewed as a temporary geopolitical disruption but as a sustained inflationary shock capable of reshaping monetary policy and global growth.

Oil prices remained elevated, with Brent crude trading above $108 per barrel and U.S. West Texas Intermediate holding above $102. Although prices stabilized somewhat on Wednesday, energy markets remain under severe strain after months of disruption around the Strait of Hormuz, one of the world’s most critical energy chokepoints.

The International Energy Agency warned that global oil supply is now expected to fall short of demand this year as the war continues, disrupting Middle Eastern production and shipping flows.

That imbalance is feeding directly into inflation worldwide.

“This would be a positive surprise rather than the main scenario for markets at the moment,” said Amelie Derambure, senior multi-asset portfolio manager at Amundi in Paris, referring to hopes that China could help broker peace.

“The preferred scenario for the market would be if China can influence the ceasefire or the peace in Iran but it’s considered relatively unlikely,” she added.

Her comments capture a growing shift in market psychology. Just weeks ago, many investors assumed the conflict would remain contained and short-lived. Now, markets are increasingly preparing for a longer and more economically damaging standoff.

That change is particularly visible in bond markets, where investors have become far more skeptical that central banks can pivot toward rate cuts anytime soon. Tuesday’s U.S. inflation report reinforced those fears. The data showed energy costs are once again becoming a major driver of headline inflation, complicating efforts by the Federal Reserve and other central banks to bring price growth back toward target levels. The result is an increasingly uncomfortable scenario for policymakers: weakening consumer purchasing power combined with stubborn inflation pressures.

AI As Investors’ Lifeline

In effect, markets are beginning to price in elements of stagflation risk. The resilience of equity markets, however, reflects another powerful force still supporting investor sentiment: artificial intelligence. Technology stocks continue attracting strong flows as investors bet that AI-related spending will remain robust even in a slower economic environment.

Massive capital expenditures by cloud providers and technology giants on chips, networking equipment, and data centers have helped support corporate earnings, particularly in the United States.

“There is still this belief that equities – except in a recession but that’s on no one’s radar for the moment – are better positioned to resist, or to perform decently, in this higher-inflation stronger-nominal-growth environment,” Derambure said.

That belief has become one of the defining characteristics of current markets. Investors increasingly see AI as a structural growth story capable of offsetting broader economic weakness, at least for parts of the technology sector.

Still, the sustainability of that optimism is being tested. The surge in energy prices is beginning to affect consumers globally, threatening spending patterns that underpin broader economic growth. Higher fuel and transportation costs are already filtering into household budgets and corporate supply chains.

The geopolitical backdrop remains highly unstable. Despite occasional diplomatic signals, hopes for a peace agreement between Washington and Tehran continue to fade. President Donald Trump said Tuesday he did not believe he would need China’s help to end the war, even as investors closely monitor his upcoming summit with Chinese President Xi Jinping in Beijing this week.

Markets had previously hoped China might use its influence to help stabilize the Gulf region and pressure Iran toward a ceasefire. But analysts increasingly view that outcome as unlikely.

Meanwhile, the ability of Iran to continue exerting influence over global energy flows remains a major concern. Reuters reported Tuesday that Iraq and Pakistan have reached arrangements with Tehran to continue shipping oil and liquefied natural gas from the Gulf, highlighting Iran’s continued leverage around the Strait of Hormuz.

Some shipping traffic has resumed through the strait, but investors increasingly believe disruptions could persist far longer than initially expected.

“Markets are digesting the idea that the closure could last longer than was expected last week,” Derambure said.

That realization is driving a broad reassessment of inflation risks, energy supply security, and global trade dynamics.

Currency markets also reflected rising caution. The U.S. dollar strengthened modestly, with the dollar index rising 0.2%, while the euro weakened. The Japanese yen remained under close scrutiny after recent “rate check” speculation fueled expectations that Tokyo may intervene to support the currency if weakness intensifies further.

In Britain, political uncertainty added another layer of market stress.

Government bond yields surged after concerns emerged about Prime Minister Keir Starmer and the weakening political position of the ruling Labour government following bruising local-election setbacks.

The U.K. 10-year gilt yield climbed above 5%, underscoring how markets are becoming increasingly sensitive to both fiscal and political risk. Gold prices slipped slightly on Wednesday, though the metal remains near historically elevated levels as investors continue seeking protection against geopolitical shocks and inflation uncertainty.

While Wednesday’s rebound in equities suggested investors are not yet ready to abandon risk assets, the continued surge in bond yields indicates confidence is becoming increasingly fragile.