Given the escalation in the conflict between Iran and Israel over the weekend, here is a quick update on the potential impact on markets.
As of Monday’s close, markets have largely shrugged off the U.S. attack on Iran. Equity markets traded modestly higher while oil prices have fallen. The attacks targeted only nuclear and military facilities. The only market overhang was how and if Iran would retaliate. Monday afternoon, we learned Iran’s response.
Iran launched missiles at U.S. airbases near Doha, Qatar. The U.S., with Qatari assistance, reported that they “successfully thwarted the attack’ and that there were “no injuries or human losses,” according to officials. Most personnel were evacuated last week.
Markets moved higher on what was deemed a measured response to the U.S. attacks. While we do not know if there will be any further escalation, historically, Iran’s responses have been highly calculated. Iran likely does not want a significant escalation that would draw the U.S. further into the conflict. Its air defenses have been severely diminished, and it would be extremely vulnerable to counterstrikes. Avoidance of regime change will likely be its primary objective.
What to watch now? Iran’s energy infrastructure was not targeted at the start of this conflict. However, there were hits by both Israel and Iran on energy facilities this weekend. Iran holds the world’s second-largest natural-gas reserves and fourth-largest crude-oil resources.
On Saturday, Iran claimed that Israel had set off an explosion on two natural-gas facilities at the South Pars field in the Persian Gulf. Later that day, an Iranian missile hit a refinery in Haifa, north of Tel Aviv, damaging pipelines and forcing a partial shutdown. Israel then struck the main fuel depot and central oil refinery in Tehran. Should Iran’s energy infrastructure be hit more widely, and if it pursues further retaliation to disrupt regional energy supplies or to draw the U.S. even further into the conflict, there could be more severe consequences for the oil market. One scenario could be that Israel may launch an attack on the Kharg Oil Terminal, which handles over 90% of the country's global crude oil exports.
Another concern would be the closing to the Straits of Hormuz. Per comments from Iranian officials, closing the Strait of Hormuz is now under consideration. Roughly 20% of the world’s oil and a significant portion of natural gas pass through the Strait. If Iran closes it, global oil and natural gas prices would increase. The manufacturing, transport and agriculture sectors, as well as parts of Europe, would be especially vulnerable.
To the extent the market views this as bullish for energy prices, it also implies increased inflationary pressure that would likely keep the U.S. Federal Reserve on hold and further delay rate cuts. A mitigating factor is that any impact due to a blockage of the Straits would also hurt China - a key ally of Iran and its major oil client. Saudi Arabia, a U.S. ally and regional rival to Iran, also has some spare capacity. This could help reduce any oil supply issues and related price increases should it become necessary to do so.
Even though the market response has, thus far, been subdued, this may not last. The Iranian conflict is yet another issue to add to a laundry list of concerns, including Russia/Ukraine, trade wars, tariffs, U.S. debt downgrade, and negotiations over the latest U.S. budget. We are also entering corporate earnings season. If nothing else, we believe markets will likely remain choppy. It is essential to remain vigilant and well diversified since market volatility often offers a mix of both risks and opportunities. In the meantime, FEG will continue to monitor this situation and provide updates and insight.
We hope for a peaceful resolution to this crisis.
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