Recent events strengthen our conviction that a well-diversified portfolio needs to be resilient to not only growth shocks, but also inflation shocks.
Israel’s attack on Iran’s nuclear programme and military leadership on Friday 13 June marked a significant escalation in the conflict between the two nations. The market reaction was unsurprisingly most evident in oil prices, with Brent crude prices jumping to a high of USD 78 per barrel, up from a low of USD 61 as recently as mid-May (Exhibit 1).
Scenarios and implications for oil markets
While the situation is moving very quickly, our central scenario continues to be that a sustained surge in oil prices is unlikely.
First, while Iran has historically accounted for around 4% of global oil production, its monthly exports have averaged around 1.7 million barrels per day (Mb/d) so far this year, or around 1.6% of global oil demand (Exhibit 2). If, for any reason, Iranian oil exports were disrupted, capacity exists to offset this loss. OPEC’s current spare capacity stands at around 5 Mb/d excluding Iran and Venezuela, of which 4 Mb/d sits with Saudi Arabia and the UAE. In the event of supply disruption, this spare capacity could be tapped to help mitigate any supply/demand imbalance.
While many OPEC producers do benefit from rising oil prices, they are also mindful of the global economic stress caused by higher prices, as well as the prospect of a meaningful fall in prices in a global recession.
Second, several regional players have an interest in keeping the conflict contained. The Gulf states are in the process of transforming their economies away from a reliance on oil, and this transformation requires a sustained absence of hostilities in the region.
The key risk to oil markets involves a closure of the Strait of Hormuz, located between Oman and Iran, which we would expect to be much more problematic for the global economy. The Strait of Hormuz is critical to global oil supply, with oil flow through the strait averaging 20.3 Mb/d in 2024, equivalent to approximately 20% of global oil consumption. All shipping traffic from the Gulf countries pass through the Strait – including crude oil, oil products and liquefied natural gas exports from Iran itself.
However, despite recent Iranian threats, a closure of the Strait is not our central scenario. For a start, a closure would threaten Iran’s relationship with China, which is crucial for Iran given current Western sanctions. China buys the overwhelming majority of Iranian oil exports. In fact, all Iran’s oil exports are transported via the sea, so its own trade depends heavily on the free passage of goods and vessels through the Strait. Any move to block the Strait would damage Iran’s own economy and also likely antagonise its Gulf neighbours. It is also worth noting that the Strait of Hormuz has never actually been blocked, despite several threats of closure over the past several decades.
Implications for global growth, inflation and interest rates
How central banks respond to cost shocks, such as a rise in oil prices, depends on the state of the economy. If the economy is weak and running below capacity, cost shocks can depress consumption and lead to further weakness in activity. In this case, cost shocks can prompt monetary easing to avoid deflationary pressures emerging.
But when economies are strong, with low unemployment and little spare capacity, cost shocks can generate increased wage demands and sustained inflationary pressures. In this scenario, monetary policy is more likely to be tightened or kept restrictive to limit further price rises.
We view today’s economic picture as more similar to the latter scenario, with tariffs already threatening to put upward pressure on prices and fiscal policy becoming looser in many parts of the world. Thus, we see any sustained increase in the oil price as likely to add to inflation stickiness, and therefore to modestly delay the speed of monetary easing from current levels.
More broadly, this latest shock strengthens our conviction that a well-diversified portfolio needs to be resilient to not only growth shocks, but also inflation shocks. We explain how we think investors can best achieve this objective in our Mid-Year Investment Outlook 2025.