Conflict in the Middle East – what it could mean for markets

Over the weekend, US and Israeli forces launched coordinated strikes against targets in Iran, prompting broad retaliatory actions across the region. Iran’s supreme leader, Ayatollah Ali Khamenei, died in the attack. The situation may continue to escalate in the coming days, and markets are likely to react to short-term news flow.

How have markets reacted?

The primary impact is being felt in energy markets. Oil prices spiked over 10% following news of the escalation. Attention has also turned to the Strait of Hormuz – a critical maritime chokepoint through which 20%–30% of global oil and liquefied natural gas (LNG) shipments pass. While Iran has not formally closed the waterway, vessels have reported warnings from Iranian forces, and several tanker operators have temporarily paused shipments as a precaution. These developments naturally raise questions about global energy prices, inflation, and market volatility.

It is important, however, to place events in context.

Historically, geopolitical shocks – even in the Middle East – tend to have short-lived effects on markets unless they result in a sustained disruption to energy supply. Today, despite heightened rhetoric, the strait remains open, and major oil producers have both alternative routing options and sizable strategic reserves. Energy markets have reacted, but in a measured way that suggests a risk premium rather than the beginnings of a systemic shock. A prolonged, confirmed closure of the shipping route and oil prices above $100 would likely prompt concern from central banks. At present, we are far from such a scenario, and markets are therefore likely to remain relatively unfazed by any potential inflationary impact.

The US Federal Reserve uses a model to gauge how changes in oil prices affect Personal Consumption Expenditures (PCE) inflation – its preferred measure of price rises – and the resulting interest rate response. A $10 increase in oil prices typically adds around 0.3% to PCE inflation, a level that has historically not prompted a rate hike. However, a prolonged surge in energy prices would likely make monetary policy more sensitive to developments in commodity markets.

Periods of geopolitical tension often bring short-term spikes in market volatility, but diversified portfolios – particularly those with allocations to high-quality bonds, defensive equities, and alternative assets such as commodities – tend to be resilient. Safe-haven flows into assets such as the US dollar, gold, and government bonds have already helped stabilise broader markets.

From an economic standpoint, the global backdrop remains more influential than any single geopolitical event. Growth across Europe and Asia continues to strengthen, while US activity has cooled but remains consistent with steady expansion. Inflation, although sticky in places, is trending lower across most major economies. Central banks, including the Federal Reserve and the Bank of England, are likely to remain measured, responding to underlying economic data rather than short-term geopolitical developments.

The bottom line

While the situation in the Middle East has understandably unsettled markets, it is important to maintain perspective. Episodes like this often result in short-term volatility, especially in energy, but the global economy entered this period from a position of strength.

As always, it’s important to remain well diversified across asset classes, including areas that can help cushion energy-driven shocks. 

We are monitoring developments closely and will continue provide timely updates to clients where necessary.