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Israel-Iran conflict: update on market impact
The Israel-Iran conflict continues to escalate. Since Israel’s air strikes on 13 June, which targeted Iran’s nuclear programme and military facilities and killed several top commanders, the two countries have traded increasingly deadly attacks.
- Oil prices have surged amid the attacks, with key benchmarks making further gains on top of a 7% jump in the immediate wake of the first strikes on Friday.
- Global stock markets dipped initially but European stocks made modest gains in early trading on Monday.
- Longer-term US Treasury yields have risen amid fears that a higher oil price will fuel inflation, but we think this is only a short-term effect given the current flexibility in the oil market.
- Meanwhile, the traditional safe-haven assets of gold and the US dollar have risen. Gold is close to its record high.
Our analysis
We had anticipated the risk of an escalation in Middle East conflict given heightened levels of volatility. Efforts by the US and other international powers to reach a nuclear deal with Iran are deadlocked. But unless there is a further ratcheting up of conflict, we do not see the attack as a game changer for equity markets.
So far, the impact on Iranian oil facilities has been relatively minor and even a further escalation would be manageable, in our view. Iran exports only 1.6 million barrels of crude oil a day. OPEC (mainly Saudi Arabia) has already increased production and Saudi Arabia alone has around 3 million barrels a day in further spare capacity.
But investors may need to stay watchful. Israel Prime Minister Benjamin Netanyahu has said that Israel’s operations will continue for “as many days as it takes”.
A big risk for markets – and oil prices in particular – would be from a sustained blockade of the Strait of Hormuz, the narrow waterway separating Iran from the Gulf states. Around 20 million barrels a day – a third of the world’s seaborne oil – passes through the strait and Iran has previously threatened to close it in the event of an attack. Any such blockade would likely lead to a significant surge in oil prices and pose a negative impact on equity markets, but we do not think a blockade is likely at this point. Even if it occurred, and the oil price reached 90-100 US dollars, the impact would likely be only temporary as OPEC could increase production.
We think pressure to find a solution will grow on both sides given the casualties sustained and the costs of maintaining this pace of warfare.
What may happen next?
We think the odds of a negotiated halt to the conflict appear low, given that Israel has pledged continued strikes and Iranian retaliation against Israeli civilians has made the conflict harder to stop. In our view, Israel likely has the appetite to induce regime change in Iran, beyond mere strikes on the nuclear programme.
But there may be reasons to think that tensions be managed if Iran seeks a peaceful resolution. Its leadership may conclude that it has no chance of “winning” a war with Israel and/or the US and has a better chance of staying in power through peace than continued war.
We think that, if the US allowed Israel to strike Iran only because of a real and immediate nuclear threat, then that permission would end once the threat was reduced. We also believe that although Mr Trump may welcome any prospect of a replacement of the current Iranian regime, he may not be inclined to pay the cost of seeing such a process through. A lengthy conflict against Iran could bring a sustained rise in oil prices and fresh volatility to markets.
