Escalating Geopolitical Tensions in the Middle East

Event recap

The escalation of geopolitical tensions in the Middle East represents a significant shock to global markets, primarily through the energy price channel. The region remains central to global oil supply, and potential disruptions to shipping routes—particularly the Strait of Hormuz—have already pushed oil prices higher and have increased volatility across financial markets. With that, markets have responded with a classic risk-off response: equities weakened, the USD dollar strengthened, and credit spreads widened somewhat. Government bond markets have been more mixed, reflecting the tension between safe-haven demand on the one hand and rising inflation expectations linked to higher energy prices and supply chain disruptions.

For investors, the key issue is whether the conflict remains contained geographically or evolves into a persistent energy supply shock. A contained conflict would likely produce temporary market volatility, whereas sustained supply disruptions could slow global growth and reignite inflation pressures. At present, markets appear to be pricing higher geopolitical risk premia rather than a structural economic shock, but developments in oil markets remain the key variable. Financial markets are still very volatile, with days of positive returns followed by days of negative returns on the back of statements and actions by the conflict’s actors.  Although volatile, it is clear that short-term impacts have been negative. In the table below we list some observations from markets during the now 8 business days following the start of the war.

Major Macroeconomic Transmission Channels

1. Energy Markets and Energy Prices 

Energy markets represent the most direct channel through which the conflict affects global financial markets. The Middle East remains a critical source of global oil supply, and approximately 20% of global oil shipments pass through the Strait of Hormuz. Any extended disruption to these flows could worsen supply conditions even more.

Higher oil prices impact the global economy through:

• Higher consumer energy costs
• Rising input costs for businesses
• Reduced household purchasing power
• Lower global growth expectations

Europe is particularly vulnerable to these effects due to its reliance on imported energy.

2. Inflation and Monetary Policy

A sustained increase in oil prices could slow the disinflation trend currently underway in both the US and Europe. Higher energy prices feed directly into inflation and could lead markets to reassess expectations for interest rate cuts by the Federal Reserve and the European Central Bank.

Bond markets therefore face opposing forces:

• Risk aversion, which supports lower yields
• Inflation expectations, which push yields higher

The balance between these forces will determine bond market performance.

3. Trade and Supply Chains

The conflict also increases risks to global trade routes. Shipping lanes connecting Asia and Europe pass close to the region, and heightened security risks could increase freight costs or disrupt supply chains.
Such disruptions would reinforce inflationary pressures and weigh on industrial production.

Asset Class Implications

Equities

Equity markets typically react negatively during the early stages of geopolitical crises due to increased uncertainty. However, history suggests that geopolitical shocks often produce temporary volatility rather than sustained market declines, unless the conflict significantly disrupts economic activity. Since the start of the war on Iran, we have seen the following sector performance divergence:

Globally outperforming equities sectors 

• Energy producers
• Infotech companies
• Commodity-related industries

Globally underperforming equities sectors

• Staples
• Airlines and transportation
• Trade-sensitive industrial companies

We note that European equity markets are more sensitive to energy price shocks than US markets.

Government Bonds

Government bond markets have reacted unevenly. Safe-haven demand typically pushes investors toward US Treasuries and German Bunds, which lowers yields. However, rising energy prices increase inflation expectations and may delay monetary easing, which pushes yields higher. Currently, inflation concerns appear to be offsetting some of the traditional safe-haven demand.

Credit Markets

Credit spreads have widened modestly as investors demand higher compensation for risk.
The impact varies across credit segments.

Investment-grade credit

• Relatively resilient
• Supported by stronger balance sheets

High-yield credit

• More vulnerable to slower growth
• Higher sensitivity to financing conditions

We note that companies with energy-intensive cost structures may face margin pressure if oil prices remain elevated.

Currency Markets – USD vs EUR

The US dollar has strengthened against the Euro since the escalation of tensions, caused by the following factors:

• Increased demand for the US dollar for purchasing more expensive oil and LNG
• Save-haven demand (note that gold has not provided the usually expected safe-haven)
• Europe’s higher exposure to energy price shocks
• Relatively stronger economic resilience in the United States

If energy prices remain elevated, the Euro is expected to remain weaker versus USD

Below we provide insights into three potential scenarios;

Scenario 1: Contained Conflict (Anthos Base Case – Most Likely/Market Implied)

In this scenario the conflict will be contained and volatility starts to subside. The US and Israel will declare that their military goals have been achieved and that despite the lack of a regime change the weakening of the Iranian political and military power structure and its nuclear complex was the main goal. 

Effects on markets are likely to be 

• Oil prices stabilize below USD 100
• Equity markets recover after initial volatility
• Bond yields stabilize
• Credit spreads narrow

Scenario 2: Prolonged Regional Conflict (Heightened Risk - Escalation Scenario)

In this scenario all actors will prolong their military strikes in the region, whilst energy supply will be defended as far as possible. The US and Israel have regime change as the ultimate goal. Negative effects on markets will be stronger, and volatility will remain for longer:

• Oil prices exceed USD 120
• Inflation pressures increase
• Central banks delay rate cuts
• Equity markets face sustained pressure

Scenario 3: Major Global Energy Supply Disruption (Tail Risk – Low Probability, High Impact)

A severe disruption to oil supply could trigger a global energy shock similar to previous oil crises, resulting
in stagflationary conditions characterized by slower growth and higher inflation, mainly through oil prices
exceeding USD 150 for a prolonged period.

• Oil prices exceed USD 140
• Inflation pressures increase even more and Global GDP is expected to decline significantly, especially in Europe
• Central banks and governments will revert to accommodative monetary and fiscal policies to prevent stagflation, probably by subsidizing energy.
• Consumer spending will fall and with that earnings and earnings growth of companies, providing sustained pressure to Equity markets

Conclusion

The escalation of conflict in the Middle East represents a meaningful geopolitical risk for global markets, primarily through its potential impact on energy supply and inflation dynamics. While markets have reacted with a typical risk-off pattern, the key determinant for asset prices will be whether the conflict results in sustained disruptions to global oil supply. At present, the most likely outcome remains a contained conflict with temporary market volatility, although energy markets will remain the critical variable to monitor.

In times like these, where events are following in rapid succession and economic uncertainty makes markets very volatile, there are no direct wise moves. There, however, is market wisdom in the portfolios managed by Anthos, in that, they are designed for diversification, and resilience in times like these. History also shows that the impact of geopolitical shocks typically fades over time. As long term investors, Anthos prioritizes the strength that comes from staying invested. Our flagship portfolios have successfully navigated previous periods of disruption - including the Global Financial Crisis, COVID 19, and the war in Ukraine - and continue to be positioned for durability through future challenges. 

Anthos will continue to monitor developments closely and assess the implications for global markets and portfolio positioning.