Middle East conflict: Eleven weeks on

What’s changed? Last week’s events suggest to us that the Strait of Hormuz crisis remains in a holding pattern with no clear resolution forthcoming. We revise our scenario probabilities in the overleaf with increasing conviction in a holding pattern.

Markets were hopeful for Presidents Trump and Xi’s meeting in Beijing last week to bring some positive news but were disappointed. Both Presidents agreed that the Strait of Hormuz must open and that Iran can never have a nuclear weapon. But there was little signal of how the reopening would be achieved. From China’s perspective, a cessation of hostilities would be economically beneficial. Although China has diversified its energy mix through coal usage and rapid renewable build-out, oil imports fell sharply by 20% y/y in April, highlighting the lingering sensitivity to Middle East disruptions.¹ Still, oil imports from the Middle East only accounted for about 8.7% of China’s primary energy consumption, using 2024 figures.²

The US Treasury let the general license authorizing purchases of Russian seaborne crude expire on Saturday May 16, after a month-long extension. India had lifted Russian imports of crude to a record ~2.3 mb/d in May.³ The expiry likely tightens the crude market further.

Reports emerged that Saudi Arabia and the United Arab Emirates (UAE) are believed to have carried out strikes on targets in Iran, according to sources from Reuters and the Wall Street Journal. Saudi and Emirati officials have denied any connection to the attacks.⁴ If true, this would mark the first such attack by Iran’s neighbours since the Middle East conflict began and may be indicative of drifting confidence in US-led actions.

The UAE also announced expansion of the the existing Habshan-Fujairah pipeline bypassing the Strait of Hormuz. Reports are vague, but some suggest that could double capacity to ~3.6mn bbl/day.⁵ Completion is expected by the end of the year. This does not change the calculus in the immediate energy crisis but is a sign, in our view, that regional players are preparing for continued destabilization of the Strait—and potentially an indication that policymakers are losing faith in a near-term resolution to the conflict.

Markets: The Iran conflict weighed on markets last week as front-month Brent oil contracts climbed above $109/barrel. Natural gas contracts in Europe climbed, rising to their highest price since early April.⁶ Markets appear to have priced in some surprise announcement from the Trump-Xi summit that was not forthcoming, leading to Friday’s oil repricing.

Global equities were roughly flat for the week, though US stocks managed a small rise while European stocks were hardest hit as energy prices weighed on assets. The dollar strengthened while US bond yields bear steepened, likely in response to the worse-than-expected US inflation report.⁷ While headline inflation was always expected to climb in April, core inflation rose by more than anticipated and producer prices also surged.⁸ Credit spreads, meanwhile, showed little change.⁷

Central banks: Markets inched up forward rate expectations last week across major central banks as inflation breakevens crept up and US PPI came in solidly above expectations.⁶ If the Hormuz crisis resolves before Q3, we think most of these hikes will be taken off the table.

What to watch: We continue to monitor passthrough effects from higher energy prices, particularly through inflation and producer price readouts. Preliminary PMI data for major economies next week will be of interest. We also continue to watch transits through the Strait of Hormuz, which remain severely depressed versus pre-conflict levels.

So what? Over the medium term we remain positive on equities, prefer non-US markets over US markets, and expect the USD to be lower by year-end. However, news can change quickly, so we continue to think that prudence rather than conviction should guide positioning. Our latest scenario set and key charts are shown overleaf.

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