The recent geopolitical event sent shockwaves through the financial system. The conflict between the United States, Israel, and Iran has generated a new crisis, which shows the growing unpredictability of the world we live in.
As the war in the Middle East continues into the second week, any military action and new reports showing military escalation directly influence how the market reacts and how prices react to market uncertainty. For investors, the Middle Eastern conflict isn’t new; what’s different this time is how it’s impacted global markets, including oil, gas, and everyday costs.
Overview of the conflict’s market impact
Last week, the United States and Israel attacked Iran, and markets have reacted swiftly to the uncertainty. Investors took a risk-off stance, reallocating assets to hedge against potential inflation. A few hours into the conflict, Asian and European equities dropped, primarily due to heavy reliance on Middle Eastern energy.
The STOXX 600 closed 1.7% lower following the conflict, at its lowest level in two weeks, after the market shock. In contrast, the US dollar has strengthened as it has returned to its previous safe-haven status.
Interestingly, Bitcoin and the broader crypto market saw an initial increase, even as investors braced for a market downturn. As fiat currency becomes less reliable during conflicts, digital assets often regain appeal as a medium of exchange. However, despite briefly surpassing $71,000, Bitcoin failed to hold above $70,000.
Expected Federal Reserve interest rate cuts are now being pushed further into the future by the market, as sustained higher energy prices can fuel inflation.
The critical role of the Strait of Hormuz
A point of inflection in the entire conflict is the Strait of Hormuz, which is the main reason markets have reacted more sharply. In the early days of the conflict, Iran announced it would close the entire Strait, which it controls.
For context, 20% of the global oil supply, or 20 million barrels of oil, passes through the Strait of Hormuz. Following strikes on oil infrastructure in the UAE and other key regions, the global oil trade has been paralyzed. As data shows, fewer than a few ships can transit through the Strait. Data from Marsh shows insurance has increased 4-6 times from the previous week, costs that are directly offset on the market.
When the strikes began, oil prices immediately jumped by about 8%, and European gas prices surged by 20%. Europe is particularly vulnerable to LNG shortages. If flows through the Strait remain curtailed, European nations will be forced to compete directly with Asian buyers on the spot market. This competition will drive up industrial energy costs across the continent, complicating efforts to lower inflation and refill gas storage levels effectively.
With shipping slowing to a near standstill following the initial strikes, the global energy supply chain is facing severe market disruptions.
Scenarios for equity markets
The equity markets are similarly exposed, as the risk-off strategy is pulling money from capital markets as investors look for ways to preserve their portfolios. There are, however, a few scenarios to consider.
If the conflict is expected to resolve soon, equities are likely to dip and then recover to new highs. But recent developments make it less likely, since both the US and Iran are pushing different narratives. The upside is that oil and defense sectors will likely outperform the market.
On the flip side, a prolonged conflict lasting more than three months could push the price above $130 per barrel, leading to further global market disruptions. The worst possible outcome is a potential recession in Europe and the US. At the same time, bond prices would likely decline amid rising inflation concerns, and equity markets would face significant downward pressure.
A rapid de-escalation, which isn’t yet forecasted, could help push oil prices below $80. While this is less likely given that the Strait is still controlled by Iran, the UAE and other major oil exporters could be seeking alternatives to continue exporting oil through other routes.
Navigating the kong-term economic outlook
High energy prices and inflation fears feed into the potential for a global recession scenario. Trump’s expected results contradict what’s currently happening. The global oil shortage is mostly affecting the EU and Asian markets; however, the US economy has entered this conflict from a position of relative strength, with manufacturing recovery and contained baseline inflation expectations.
Whether this upward trend continues depends on the US market’s ability to outperform European and Asian markets. While defense stocks are often considered a hedge, it is important to note that they cannot sustain the entire US market on their own.
Building portfolio resilience
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