middle east conflictcurrent situation and market impacts

The United States and Israel have launched an offensive against Iran

The offensive launched this weekend by the United States and Israel has significantly heightened risk aversion at the start of this week. The last few hours have seen the conflict in the region continue, with Tehran adopting a firm stance, rejecting any return to the negotiating table with Washington for the time being and putting in place the succession of Supreme Leader Ali Khamenei. In the short term, this is causing increased volatility for risky assets, particularly European equity indices, which are more exposed to rising oil prices. Conversely, gold continues to perform well beyond short- term profit-taking to offset losses on other financial assets in recent days, while the impact on sovereign rates should be more contained, between rising inflation expectations on the one hand, which have driven sovereign rates since Sunday, and fears about growth on the other.

The Middle East at a crossroads

Faced with the failure of diplomatic efforts to negotiate an agreement with Iran, Donald Trump decided to attack the country on Saturday, February 28, with Israel's support. While this offensive was not a surprise, its scale and intensity were astonishing, as was Tehran's response, which sought to regionalize the conflict (strikes in Saudi Arabia, Qatar, Kuwait, etc.) claiming to target US military sites, thereby increasing cost of the US campaign and try to disengage the oil monarchies, without success so far. At the same time, immediate retaliatory measures by Iran and its proxies (including Hezbollah) have extended the conflict to many neighbour countries, while paralyzing the Strait of Hormuz, through which one-fifth of the world's oil passes. At this stage, calm still seems a long way off, with Iran also attacking hydrocarbon production sites since Monday and Trump even going so far as to mention an offensive lasting four to five weeks, or even longer. An attempt to resume dialogue between the Iranian and American leaders has been mentioned by Trump, but has been denied by Iranian representatives for the time being.

In the short term, the situation is uncertain, but we believe that a total collapse of the current regime and the Islamic Revolutionary Guard Corps (nearly 200,000 men) is unlikely without a large-scale ground operation, which the United States does not seem ready to launch. It will therefore be necessary to monitor the ability of both sides to return to the negotiating table, a scenario whose timing remains difficult to predict.

The following factors will be key in the coming days and weeks: 1/ the ability to navigate the Strait of Hormuz; 2/ the willingness of the new Iranian provisional government to negotiate; 3/ the position of the Iranian people, who could seize the opportunity to regain control; 4/ the reaction of China, half of whose crude oil imports pass through the Strait of Hormuz; 5/ ultimately, the position of Donald Trump, who is also campaigning for the midterm elections and therefore wants to avoid a major and sustained surge in energy prices.

Financial markets: longer-term outlook and expectations

The economic implications of the conflict will be highly dependent on oil prices, themselves closely linked to the operability of the Strait of Hormuz. Between 10 and 15 mb/d of crude are at risk, even though short-term effects may be softened by alternative routes (Saudi East-West pipeline) and pre-positioned inventories. In this context, the sensitivity of general inflation in Europe is expected to rise by more than 1.0% for every $10 increase in oil prices, while the impact on real GDP would be around -0.3%.

We believe that the current situation does not call for a specific reaction from Central Banks at this stage. They will nonetheless monitor conditions in the Strait, as well as the risk of Iranian strikes on strategic energy assets (pipelines, refineries, storage), which—if they caused major supply disruptions—could push the barrel above $ 100/b.

In the short term, caution remains recommended pending greater visibility regarding the intensity and duration of the conflict. Over a longer horizon, we consider it unlikely that D. Trump will allow the United States to become bogged down in Iran—a conflict opposed by a majority of Americans ahead of the November mid-term elections—especially since rising oil prices undermine his fight against inflationary pressure and his support for household purchasing power. Meanwhile, investors’ capacity to regain risk appetite following prior shocks should not be underestimated, often helping equity markets and risk assets rebound as soon as conditions stabilize.