We expect market reactions to hinge on whether oil flows are disrupted through the Strait of Hormuz.
We outline four broad scenarios for potential impacts, from stable supply with increased OPEC output to severe disruptions.
We’ll be monitoring crude futures, the US dollar, OPEC+ decisions, and shipping movements through the Strait of Hormuz.
The market reaction on Monday 2 March was more subdued than many might have expected. US and Chinese equities even closed the day higher1. There was little evidence of a strong risk-off move.
Thus far markets appear to be pricing inflation risks more than an oil supply shock that tips the economy into recession. This is evidenced by a rise in sovereign bond yields around much of the world. Among major government bond markets only Japanese government bonds appear to have played the “safe-haven” role, as yields fell on Monday2.
As for oil, the first Brent future traded at $82.37 at one point on Monday but was around $78.42 heading into the close of trading, for a gain of around 8%2. Since June 1988 that is the 37th largest one-day move in the first Brent future. This suggests market participants think oil might be a bit harder to get, but it won’t be trapped in the Middle East.
A further explanation could be that futures positioning in oil was already long headed into the weekend. These positions are higher than they were in 2003 (US invasion of Iraq) and 2022 (Russian invasion of Ukraine), for example, when we observed larger one-day moves in the price of oil.
Implied volatility for oil in three months’ time has moved higher, higher than we saw in June last year3. That indicates that some traders expect this conflict to be prolonged, which does seem likely.
Natural gas rallied more aggressively than oil – by around 40% on Monday2. The catalyst for that move was a drone strike on energy facilities in the Qatari industrial cities of Ras Laffan and Mesaieed. QatarEnergy confirmed it has ceased production of liquefied natural gas (LNG) and associated products at these facilities. This potentially removes around 15% of total LNG supply globally. Similarly, Saudi Arabia's Ras Tanura oil refinery (which produces 550,000 barrels per day) was hit by drone strikes and has halted operations.
Gold and silver traded higher through most of the day, but towards the end of the day silver was trading lower than Friday and gold was largely flat2. Again, we did not see a rush to these “safe haven” assets. Equally, the rally and some speculative positioning already in these markets could explain the less strong move.
European equity markets behaved as expected trading weaker, with the UK market trading less poorly, supported by its higher weight in energy stocks. US stocks traded higher suggesting that investors are not rushing to haven assets and that they believe US earnings are less vulnerable to energy shocks
The US dollar gained a little against the euro, Japanese yen, British pound, and most emerging market currencies2. That gain could reflect safe-haven buying, but it may also reflect the steeper rise in US yields. Interestingly the euro/Swiss franc exchange rate was higher; that move is harder to explain.
At present there is a soft closure of the Strait of Hormuz. On 2 March just two vessels passed through the Strait2. Normally we’d expect around 115 vessels per day moving through.
This doesn’t necessarily mean that our fourth scenario (described in our article below) is playing out, though there are reports of more threats from Iran on ships in the region. We’ll need to update the probability of our scenarios as we get more data on ship movements. For now, it could just be that insurers are reassessing the risk and have not reinstated the contracts they pulled over the weekend. We must watch these shipping figures through the rest of week to get a better assessment of the impact on oil supplies.
Overall, the relative calm in markets suggests inflation rather than recession is the greater risk. The disruption to natural gas supplies is concerning though and could be a signal of broader attacks by Iran on infrastructure in the region raising the probability of scenario three or four below playing out in some form.
We must now watch for further physical disruption to oil and LNG and how quickly Qatari and Saudi gas repairs take.
Over the weekend, the United States and Israel launched a coordinated military assault on Iran. Iran retaliated with missile and drone strikes on US military installations across the region. What could this emerging situation mean for markets? A core tenet to our view is that markets typically look past geopolitical events unless they materially alter economic fundamentals. To help determine what might come next, we offer four possible scenarios for what we could face in the coming weeks, and explore the possible reaction of various asset classes.
As we write this on Sunday, March 1, this is what we understand the current situation to be.
Early on Saturday morning, the United States and Israel launched a coordinated military assault on Iran. The scale of these strikes was larger than we’ve seen in the recent past, and Iranian state television has confirmed Supreme Leader Ayatollah Ali Khamenei was killed. Iran has retaliated with missile and drone strikes on US military installations across the region. Civilian areas have been hit in Dubai and Doha, but it is not clear whether these were targeted explicitly.
We have not seen any reports of oil facilities across the region being hit or disrupted at this point. Iranian media claims the Strait of Hormuz is effectively closed, though the state hasn’t issued an official blockade. A few ships have been attacked and the latest we have seen is that many are starting to drop anchor rather than travel through the Strait at this time.
US President Donald Trump and Israeli Prime Minister Benjamin Netanyahu have stated they are pursuing regime change. This means it is not clear what would allow them to quickly declare victory and de-escalate. The situation remains incredibly fluid. The absence of well-defined objectives means the prospect of a prolonged campaign is heightened.
We believe the initial reaction in markets is likely to be risk-off, but it might not stay that way. The medium-term reaction will likely be guided by how the oil and — to a marginally lesser degree — gas markets move. That will be determined by whether oil and gas supplies are disrupted and to what degree.
In writing less than 48 hours since the first strikes, our assessment presently is that oil supplies are largely unaffected. That could change quickly. Indeed, it may not need physical restrictions, so long as markets believe such restrictions are possible.
Though the situation is highly fluid and may change rapidly, we consider four broad scenarios. Here, we list them in order from the lowest to highest impact on oil prices and markets.
Under this scenario there is a good chance oil prices could fall in the coming week or weeks. Oil prices had risen somewhat ahead of the US/Israel actions, and on March 1, OPEC+ announced a larger-than-expected production increase which could partially offset a disruption in supplies. Of course, this relies on them being able to get the oil out.
We give this scenario a subjective probability of 40%.
In this scenario, we believe oil prices would move higher but in a relatively contained fashion. Iran supplies around 3% of global oil supplies (after allowing for its own consumption), much of which heads to China. OPEC+ could perhaps step in and close any gap. We ascribe a low probability to these facilities or pipelines being targeted as Israel and the US have little incentive to drive oil prices higher through such action. President Trump’s approval rating and prospects in the mid-term elections could be damaged if oil and therefore gasoline prices rose significantly.
We give this scenario a subjective probability of 10%.
Iran has already made some symbolic strikes, but not yet on oil and gas facilities. These could be escalated and oil facilities in Saudi Arabia and others could be targeted. However, the Saudis have shown in the aftermath of past strikes that they can repair these facilities quickly. The scale of any strikes and ability to restart is the unknown now. Thus far it appears Iran has targeted mostly US bases but not oil facilities or transport yet.
We give this scenario a subjective probability of 20%.
The final scenario is the most worrisome. Iran and its proxies do not need to physically block the Strait, they can just increase the risk of transit enough to raise the cost for ships to move through — specifically, the costs of insuring a ship. Already, war insurers of vessels are reporting that premiums to cover ships in the region could rise by up to 50% in the coming days.
A de facto partial blockade via the insurance market rather than a physical one caused the Red Sea effectively to close to much commercial traffic in late 2023/early 2024. The difference is that there were alternative routes to the Red Sea, around the Cape of Good Hope, but there is no alternative to the Strait of Hormuz. This is why watching the number of vessels moving here will be so critical to oil markets in the coming days. That said, a pipeline exists in the United Arab Emirates that could divert oil to ports that avoid the Strait of Hormuz.
We believe this would be the most damaging scenario, with the global supply of oil and liquefied natural gas (LNG) restricted. Asian countries are perhaps the most vulnerable, especially Japan and Singapore.
We give this scenario a subjective probability of 30%.
We anticipate the initial market reaction will very likely be one of a risk-off nature:
We expect equities to move lower in the immediate aftermath of these events, but the outlook thereafter hinges on how the situation unfolds. Most of the effect is likely to be felt through higher oil prices. In other words, we expect energy producers will fare better than energy consumers. Within equities, we believe cyclical and consumer sectors are likely to be hit hardest. Defense, major energy companies, and gold miners would likely be the obvious beneficiaries of this kind of geopolitical shock.
In terms of regional characteristics, European equities are structurally more exposed to energy price shocks than US markets, given higher energy intensity in industry and greater dependence on imported hydrocarbons. This also applies to Japan. Many emerging markets that rely on foreign energy sources are at risk, but energy-producing nations are likely to fare better. We also note that many Asian economies rely on imports from the Middle East, which may result in downward pressure on local assets.
We think that bond yields could rise in the short term on concern about higher inflation, though falling real yields (on concern about economic growth) could dampen the effect. It is possible that some government bond markets could benefit from so-called “safe haven” demand, but we think inflation concerns would dominate. On that basis, and given the energy independence of the US, we suspect US Treasuries may be less impacted than European and Japanese government bonds. We would expect high yield bonds to suffer a widening of spreads, as economic concerns build.
Normally we’d expect the dollar to rally in an early risk-off scenario, and that may be the most likely outcome now. However, the so-called “safe haven” status of the USD has recently been put in question. We expect the currencies of energy-exporting nations to strengthen, including the Canadian dollar, Mexican peso, Norwegian krone and Middle East currencies (though the effect on the latter may be dampened by the proximity to conflict).
We expect prices to rise initially, reflecting elevated risks. But as we outlined above, there are a range of possibilities for how oil and gas prices evolve. We believe the most likely outcome is that Iran’s military capabilities are disrupted, but that its oil facilities are not and that the Strait of Hormuz remains open. This would suggest a relatively modest boost to energy prices in the medium-term, in our view.
We believe that gold and silver prices are likely to rise as markets digest a new wave of geopolitical uncertainty. Even if the Strait of Hormuz remains open, we anticipate precious metals to benefit from greater uncertainty.
As noted above, we are monitoring the situation, particularly around the Strait of Hormuz. Tanker movements, US Navy statements, and insurance market rates are likely to be key areas of interest in the coming days. Similarly, Saudi Aramco and Abu Dhabi National Oil Company communications on infrastructure status could allay or heighten market concerns, depending on how missile strikes evolve.
There are historical analogies for what might happen, but they are imperfect now as this conflict is a more direct and escalatory confrontation. Still, they underscore a key market dynamic: Without physical infrastructure damage or durable Hormuz disruption, spikes in crude (and natural gas) tend to fade as supply concerns prove transient. The key difference today is that Iran has already signalled and executed far wider retaliation than in any prior episode.
However, we emphasize that most actors here do not want to see a major oil supply shock that harms the US and global economy. These are troubling and very fluid events, but based on the information we have today, we haven’t materially change our core views this weekend.
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