Why is the outlook so unpredictable? No one yet really knows how severe the response of a cornered Iran and its proxies will be.
In the event of escalation, the risk is the entire Middle East and the US could be dragged into a grinding war that no one – especially markets – had anticipated just weeks ago.
But in his White House address, in which he described the strike as a “very successful attack”, Trump warned he could bomb more Iranian targets unless Tehran dismantles its nuclear program. This means the US President is now committed to yet another war in the Middle East.
Markets will now be trying to navigate both the short-term and long-term implications of Trump’s intervention, and both timelines are filled with bad news.
The short-term shock will be more predictable. Oil prices will spike immediately, and depending on Iran’s response in the next 24 hours, potentially passing the critical $US100 a barrel for Brent crude when global commodity markets reopen. As a benchmark, $US100 is the equivalent of the second OPEC oil shock of 1979 in today’s dollars.
If oil holds at these levels, this will stoke inflation (including in the inflation-prone US economy) and set off a second-order hit to confidence, as well as a headwind for spending and investment. At the pump, petrol prices are influenced by futures pricing and these too will start moving higher immediately.
Slow start
The one positive to this has been the low starting point for oil. Importantly, for most developed countries, inflation has come off its post-Covid highs.
At the start of the month, crude was trading at four-year low of around $US61 a barrel, itself weighed down by surplus production and a slowing global economy (thanks to the prospect of Trump’s tariffs). Oil has already jumped more than 25 per cent this month to $US77, with most of the gains coming in the past week after Israel launched its strikes against Iran.
If Iran and neighbour Yemen attempt to close off the Persian Gulf, through which more than 20 per cent of the world’s oil flows, then hold on. Oil will pass the near $US120 a barrel peak reached on Russia’s invasion of Ukraine. The crimp to Australia’s economy from record petrol prices would be the equivalent of an interest rate hike.
Gas markets are also expected to react, with Iran a major exporter of gas to Turkey. Expect a new round of energy pain, although Europe has been attempting to diversify its imports since Russian gas was shut out of the market.
Long term
The longer-term implications of the conflict are yet to be written. In a world where the frequency of big geopolitical shocks seems to be rising, markets have so far taken much of these in their stride.
Wall Street is just off record highs, more than recovering from Trump’s tariffs. Australian shares also hit a fresh record this month. The US continues to sell its long bonds – although at a price – even in the face of nagging worries about the explosion of debt and no attempt to bring it under control.
However, if oil disruption lasts beyond the northern hemisphere summer, there’s real cause for concern.
The International Energy Agency has estimated that for every US$10 per barrel increase in oil prices, this reduces global GDP by around 0.5 per cent in the following year, and boosts consumer prices by a slightly larger amount. There are plenty of tail risks here from a long war.
Meanwhile, a wounded Iran could strike at the oil infrastructure of its Middle Eastern neighbours that host US bases – including in Saudi Arabia, the world’s biggest oil producer.
Even regime change in Iran could spark a civil war, with control of oil set to be the prize among warring factions. Just how much the Middle East is reshaped on the back of this war will be hard to tell.
This month, the OECD cut its forecasts for global growth, projecting 2.9 per cent this year and just 1.5 per cent for the US economy. It warned that inflation could be coming back in some economies given the pressure on global trade from Trump’s tariffs.
“The slowdown is expected to be most concentrated in the United States, Canada, Mexico and China, with smaller downward adjustments in other economies,” the OECD said. The World Bank raised similar fears just last week.
In essence, the global economy has been finely balanced heading into this conflict. The real concern is the ripples flowing from this event could be the thing that puts markets off balance.
There are a few events coming that could help push this uncertainty along. There’s a looming deadline of July 8 for Trump’s reciprocal tariffs and another on August 12 for China tariffs to be negotiated.
Trump twist
For markets there’s another big lesson out of the weekend bombing: Trump actually following through on a threat.
Since the initial sharemarket hit of his sweeping “Liberation Day” tariffs in early April and later pullback, the dominant momentum for markets has been around TACO: Trump Always Chickens Out of his threats.
In other words, Wall Street was making bets on what Trump does – which is a propensity for de-escalation – rather than what he says loudly.
The Iran conflict was shaping up as yet another TACO event. Even after all the tough talk of last week, the US President issued another two-week deadline for Iran to negotiate.
It was these comments that lulled markets into a false sense of security, allowing sharemarkets to hold ground despite a backdrop of two sworn Middle Eastern enemies shooting missiles at each other.
Trump’s first serious international military action against a big, volatile target has upped the stakes yet again for his ability to surprise. That’s another twist that’s set to redefine Trump’s relationship with Wall Street, let alone the world.
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Donald Trump’s entry into the Iran war will deliver a new and entirely unpredictable financial shock. Oil still powers the global economy, and surging prices are likely to deliver another blow to growth. Australia will feel the financial pain of sky-high petrol prices.