Iran conflict

Read this article to understand:

• Why the market reaction so far has been muted
• Key geopolitical and macroeconomic risks
• The continued importance of diversification and risk management for long-term investments

The assessments in this article were correct at the time of writing but may change quickly.

The US strikes on Iran and subsequent regional retaliation were broadly expected, limiting the initial shock to financial markets. However, the US aim of regime change marks a key escalation compared to prior episodes, and the long-term effects will hinge significantly on the effect on oil supply and prices.

• The market reaction is contained so far: Oil prices rose, as did the dollar and gold, while equities dipped modestly and bonds were little changed. The moves are consistent with a modest, oil-driven move to risk-off.
• A key risk is oil-supply disruption: Oil production outside Iran is unaffected, but shipping in the Strait of Hormuz has almost come to a standstill. Further disruption could push oil above $100 a barrel and trigger a much larger global risk-off move.
• The macroeconomic impact depends on duration and oil prices: Current moves are not helpful to growth, but a sustained oil price of $100 a barrel would likely shave 0.2 to 0.3 percentage points off global growth, push equites down more sharply and materially raise inflation, hitting oil-importing economies hardest.

The US attack on Iran came as no surprise to global markets, with the build-up in US military over recent weeks and months suggesting a strike was imminent. Indeed, markets had expected it to happen sooner.

The surprise was that the US is actively seeking regime change in Iran through domestic popular support, following the elimination of the senior leadership in an air strike on Saturday. This makes the strike quite different to June last year, when the US bombed Iranian nuclear and military facilities and the Iranians responded with a well-flagged and ineffective bombing of Qatar.

The Iranian regime has, unsurprisingly, responded far more aggressively this time, with missiles and drones fired against multiple neighbours in the region: Israel, Kuwait, Saudi Arabia, the UAE, Qatar, Bahrain, Iraq and Cyprus.

This morning, Hezbollah also entered the conflict, leading to significant actions in Lebanon by the Israeli military. This highlights the risk of war spreading further.

President Trump has said that US action in Iran could last four to five weeks to achieve objectives, while various Iranian officials have said they are open to de-escalation talks. However, there is a risk the conflict could widen and last longer.

Oil production outside Iran is unaffected, but shipping in the Strait of Hormuz has almost come to a standstill. Further disruption could push oil above $100 a barrel and trigger a much larger global risk off move.

Market reaction contained

So far, the market reaction has been fairly contained, suggesting the attack was both expected and remains within the realm of a short-term conflict with limited impact on global finance.

This is a classic oil-supply-driven risk-off market reaction. The correlations implied by the moves above are consistent with historical experience. The magnitude is, so far, modest. A wider conflict that materially impacted oil supply could push oil prices above $100/barrel and would likely lead to a wider risk-off move in markets, with equity likely to fall by as much as ten to 20 per cent, with the US dollar strengthening and sovereign bond yields falling.

In terms of regional economic impacts outside the Middle East, oil importers will be hurt most – for example the Eurozone, UK, China and other parts of Asia – while net exporters or countries that are largely self-sufficient will be more insulated and may even benefit from a higher oil price.

The magnitude of the move in oil prices so far is not enough to materially impact global growth. But a move to $100/barrel would likely knock around 0.2 to 0.3 percentage points off global growth in our estimates. A sustained ten per cent move higher in oil prices could raise CPI inflation by around 40 to 80 basis points in most major economies, implying 160 to 320 basis points for a move in oil above $100/barrel. 

For central banks where inflation remains above target, a sustained increase in oil prices would push inflation further away from target. In those circumstances, the timing and magnitude of rate cuts would likely be pushed out or reduced.¹

Our positioning

Periods of heightened geopolitical tension unavoidably impact global markets. Our investment approach is built around broad diversification across asset classes, regions, and risk factors. We explicitly consider these environments within the construction and ongoing management of our portfolios, with the aim of moderating volatility during periods of uncertainty.

While short-term market reactions can be unpredictable, history shows that well diversified portfolios, anchored to long-term fundamentals rather than headline risk, are typically well-placed to navigate ongoing geopolitical events.

Our portfolios across asset classes do not have any direct exposure to Iranian assets.