Markets Tumble As The Iran Conflict Worsens

Photo by Jason Briscoe on Unsplash

• Markets tumble as the Iran conflict worsens

• Early crude spike eases as G7 weigh up releasing reserves 

• US inflation due this week as Fed rate cut prospects fade

Global equity markets have been dealt a significant blow as we kick off a new week, with traders waking up to the potential consequences of the Middle East conflict that only ever seems to deteriorate by the day. While much of the past week was spent hoping that this would be a short-term conflict that ultimately resolves with oil flowing globally once again, the weekend targeting of Iranian oil facilities spells out a new phase to the conflict that ultimately brings significant consequences for the long-term supply dynamic once the dust settles. For European markets, the prospect of a prolonged period of disruption leaves the region exposed, as many wonder whether they could soon return to Russian energy markets despite the ongoing conflict in Ukraine. In fact, Russia stands as potentially the biggest benefactor of this conflict, with the discount on Urals crude shrinking by the day as buyers clamour for energy irrespective of the source.

The early gains seen for crude took WTI into $120, with that initial 30% spike marking the biggest one-day gain since April 2020. This comes as the world faces up to the largest oil supply shock in history, representing a drop-off of roughly 20 million barrels per day (20% of global output). For the time being, there are efforts being made to mitigate much of this drop-off, with the G7 nations apparently in discussions over a potential joint release of oil from their reserves in a bid to stabilise the markets and buy additional time for operations to continue in Iran. With the G7 currently holding roughly 1.2 billion barrels in reserve, the US are apparently calling for a release in the 300-400 million barrel region. Nonetheless, while this could keep a lid on oil prices over the short-term, the implications of a continued conflict remain widespread in nature, with concerns over the flow of natural gas, fertiliser, sulfur, and potential attacks on desalination plants.

Looking ahead, this week provides a fresh insight into US inflation through the release of both CPI and core metrics. However, traders will be well aware of the direction of travel for prices as energy markets soar higher. The prospect of a short-term spike in energy prices looks increasingly unlikely by the day, with the attacks on oil production facilities throughout the Middle East raising the length of time it would take to bring output back to normal in the event of a resolution to this crisis. While the Federal Reserve are typically encouraged to look through one-off, short-term price shocks, the prospect of an extended period of higher costs for businesses does highlight the risk that they pass that on to the consumer who already faces up to higher prices at the pump. Markets are pricing a single 25bp cut for 2026, although even that might be over-optimistic if we see a drawn-out conflict that wipes out a fifth of global oil supply for an extended period of time.