Market Snapshot: Escalating Conflict in the Middle East

The United States has joined the conflict in the Middle East, bombing three nuclear installations in Iran over the weekend. While forecasting the trajectory of geopolitical conflict is notoriously difficult, Iran’s response will be particularly telling in shaping the economic implications.

From a direct economic standpoint, the Middle East accounts for a relatively small share of global activity – roughly 5% of world GDP, trade and population. However, in an interconnected global economy, disruptions in the region can have far-reaching consequences. Second-order effects warrant close attention, particularly the potential impact on energy markets and the maritime chokepoints critical to their global distribution.

The Middle East is home to three of the world’s key shipping chokepoints: the Suez Canal, the Bab al-Mandab and the Strait of Hormuz. The latter has drawn particular focus given its proximity to Iran and the risk of closure amid an escalating conflict. Disruptions at any of these chokepoints could significantly impair global trade routes for energy and other goods  moving between the major economies of Europe and Asia.

Oil and petroleum-related products are top exports for several Middle Eastern nations, with the region accounting for roughly a third of global crude oil production. Any material disruption to supply could reverse the decline in oil prices, which has been a key contributor to the year-to-date moderation in the Consumer Price Index.

Iran alone represents about 4% of global crude oil production, a figure that happens to roughly match OPEC’s current spare production capacity. In theory, this suggests that a disruption to Iranian output could be offset over the medium-term with limited market dislocation. However, that assumes the conflict remains geographically contained. Should tensions spill beyond Iran’s borders and impact other major oil-producing neighbors, the resulting supply shock would likely be far more difficult to manage. As such, the scope and duration of the conflict will be critical to monitor in the days and weeks ahead, particularly for their downstream impact on inflation.

Tariff-related price increases were already anticipated to begin reaching consumers over the summer. Now, with the added potential for elevated energy prices, concerns are mounting that inflationary pressures could become more pronounced and persistent than previously expected.

From a broader perspective, investors should be cautious about making material shifts in asset allocation based solely on geopolitical developments. History offers no shortage of events that appeared near-cataclysmic in the moment and triggered meaningful volatility. Yet, time and again, equity markets, especially those outside the immediate conflict zone, have demonstrated a remarkable ability to recover and resume their long-term growth trajectory. De-risking portfolios in environments where investors have limited predictive power can carry meaningful opportunity costs, especially if markets, as they often have historically, look through near-term risks.

Jason Pride, CFA
Chief of Investment Strategy & Research
Glenmede

Michael Reynolds, CFA
Vice President, Investment Strategy
Glenmede