As war in the Middle East escalates, investors are confronted with the reality of a world that is becoming more dangerous. With markets reacting minute by minute to the news, it’s helpful to take a step back and consider events in a broader context, suggests Capital Group political economist, Talha Khan.
“The death of Iran’s Supreme Leader Ayatollah Ali Khamenei marks a significant escalation in the long-running conflict between the United States, Israel and Iran. U.S. and Israeli military attacks targeting senior Iranian leadership represent a direct strike at regime command, rather than the type of limited infrastructure campaign we’ve seen in the past. Iran has responded with missile and drone attacks against Israeli territory, U.S. military bases and adjacent countries.
In financial markets, initial reactions reflected shock and uncertainty but not panic selling. Gold prices jumped and the U.S. dollar rose as investors sought safe-haven hedges. Oil prices moved significantly higher as traders worried about supply disruptions. But global equity and fixed income markets were more subdued amid expectations that U.S. military action may be short lived.
For now, markets are adjusting to higher geopolitical risk but not yet positioned for a prolonged regional war. Whether that happens will depend on three pivotal events: the severity of Iran’s retaliation, the security of oil flows through the Strait of Hormuz and, ultimately, the outcome of the Iranian leadership succession.”
Oil has been in the forefront as prices spiked over 75% to over $100 per barrel.
If the administration can keep the duration of this conflict to a few weeks, most economists are projecting oil prices to revert back to pre-invasion levels. But the real risk is if this escalates into a longer drawn-out war with a longer-term blockage of the Strait of Hormuz. Oil and LNG prices would jump ever further and cause a real strain on the global economy, resulting in higher inflation. Fortunately, the United States has shifted to the world’s largest producer of oil the past few years to leave us much less reliant on Middle Eastern oil. US oil companies will actually benefit from higher prices, but consumers will feel it at the pump until tankers start moving through the Strait of Hormuz.
Markets will continue to react to this ever-changing event, but we urge investors to step back and focus on the long-term. We’ve lived through numerous geopolitical events where volatility and significant concerns spike, but markets seem to always weather the storm. We urge investors to remain diversified and not overreact to these events.
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