Key Takeaways
- Investors continue to closely follow events in the Middle East – most recently the US’s strikes on three Iranian nuclear sites.
- Financial markets have responded in a relatively calm manner. There has been a small flight to safety, but equities have not seen a notable selloff. The oil price has risen but not towards levels that would impact wider risk appetite.
- Should Iran seek to close the Strait of Hormuz – a route critical to global oil supply – then financial markets would have to reassess risks. Despite a vote in Iran’s parliament, no threats to shipping have been seen yet.
- We continue to operate in very uncertain times but can take comfort from the resilience in financial markets to geopolitical risks and persistent uncertainty around the US tariffs regime.
- The backdrop is fluid and while our views remain constructive overall, we are cognisant that any deterioration in risk appetite could trigger a pause or reversal in recent momentum.
Financial markets are firmly focused on geopolitics after the recent escalations in the Middle East firstly with Israel’s attack on Iran’s nuclear program and military leadership and now with the US joining the fray following the weekend’s raids on three Iranian nuclear sites.
So is the US now drawn into a major conflict or is this ‘one and done’? That likely depends on how Iran retaliates from here. The Israel-Iran conflict continues, and Iran is operating from a position of weakness, with its most powerful allies – China and Russia – offering little support, and the military already weakened by Israeli attacks on installations and key personnel. President Trump has floated on social media the idea of regime change but there is no appetite in the US for the scale of intervention we have seen in recent years in Afghanistan and Iraq. As Vice President JD Vance said “we’re not at war with Iran. We’re at war with Iran’s nuclear programme…. We have no interest in a protracted conflict; we have no interest in boots on the ground”.
Iran targeting US assets in the region would, however, likely invite further attacks from the US. US Secretary of State Marco Rubio said “There are no planned military operations right now against Iran unless they mess around and they attack [America] or American interests, then they’re going to have a problem”.
Financial markets have remained relatively calm throughout this process – we have seen a small flight to safety, with ‘havens’ including the US dollar seeing increased demand. But equities have not seen a notable selloff, and while the oil price has shifted higher, it has not broken out towards $100/barrel or levels that would likely impact wider risk appetite. At the time of writing on Monday morning, Brent Crude sits at $78.29/barrel, which is up just over 4.5% so far this year, and up 22% so far this month. But crude oil is still trading below the $79.85 average price during 2024, and before the breakout of hostilities last week, expectations were for the oil price to drift lower thanks to strong levels of supply and softening global demand.
The key risks for financial markets remain around the oil price and potential upside risks if Iran follows through on previous threats to close the Strait of Hormuz through use of mines and missile attacks on shipping. The Strait of Hormuz is critical to global oil supply, with oil flow through the strait averaging 20.3 million barrels per day in 2024, equivalent to approximately 20% of global oil consumption. Iran exports 2 million barrels per day through the route, predominately to China. In addition, around 20 million barrels per day pass daily through the Strait from Iraq, Kuwait, Saudi Arabia and Qatar. Around 20% of global LNG supplies also pass via the Strait. The US Navy’s fifth fleet in Bahrain would likely prevent the complete closure of the route but there would inevitably be disruption. No indication of any threats to shipping have been seen so far despite Iran’s parliament passing a vote to block the Strait, albeit in a ‘consultative capacity’ rather than a binding vote.
Iran would risk the wrath of both the US and China by choosing to disrupt crude oil supply chains as well as damaging its own economy. So long as the Strait of Hormuz remains untroubled by the conflict, then the oil price should stay contained, albeit with a risk premium built in such that we’re unlikely to see the levels of early May any time soon.
We should also bear in mind that the global oil landscape is very different to 20 years ago thanks to the emergence of US shale oil, and while any issues in the Strait would certainly pose upside risks to the oil price from here, the impact on the global economy should be less dramatic than previous crises. The US now leads the world with a 22% share of global oil production; this compares to Saudi Arabia on 11% and Iran on 4% most of which is exported to China. Upside risks in the oil price may have a lower economic impact in the US than previously, but still pose upside risks to inflation, and the potential for interest rate cuts later in the year.
We continue to operate in very uncertain times but can take comfort from the resilience in financial markets, not only to the geopolitical risks but also to the persistent uncertainty as a result of the US tariffs regime, which will likely come into sharper focus as July’s deadline for negotiations approaches and if there is no further escalation in the Middle East. History shows financial markets tend to cope well with geopolitical volatility provided any ‘shock’ is anticipated to cause a limited impact on the global economy. The backdrop is best described as ‘fluid’ though, and while our views remain constructive overall, we remain cognisant that after a strong recovery from the tariff induced market wobbles in the spring, any deterioration in risk appetite could trigger a pause or reversal in recent momentum.
