There has been a significant escalation in tensions between Israel and Iran since Israel’s missile attack on Tehran on June 13. This occurred amidst the ongoing U.S.-Iran talks on a nuclear deal, with talks scheduled for last Sunday in Oman being canceled.

While conflicts so far are contained within the region, risks of damage to energy infrastructure and any broadening of the conflict will lead to higher oil prices, impacting the economy and financial markets.

Impact on oil prices

Energy prices remain the most direct channel of this conflict to impact the global economy. Risks come from two aspects:

• Disruption of energy production: Iran produces around 3.6 million barrels of oil per day, accounting for approximately 3.5% of global production. Destruction of Iran’s energy infrastructure would negate years of efforts to rebuild oil production after U.S.-Iran deals to ease sanctions, causing significant long-term impact. A worst-case scenario involves the conflict broadening to other major oil producers in the region, potentially impacting a third of the global oil output.
• Supply chain disruptions: If Iran-backed Houthis in Yemen attack ships passing through the Strait of Hormuz, a critical shipping route for 30% of the global seaborne oil trade and 20% of the global LNG supply, it could cause significant disruptions. A worst-case scenario would be Iran disrupting shipping lanes along the Strait. However, Iran is heavily dependent on the Strait, and this act could impact neighboring oil producers and global consumers. 

So far, markets have not priced in these extreme scenarios. In recent months, oil prices have faced downward pressure due to concerns of upcoming oversupply. Prices have been volatile since the Israeli attack, with Brent crude jumping 9% on Friday to touch USD 77 before easing slightly. Prices also rose 5.5% on Monday early trading but pared gains, showing investors’ continued wait-and-see approach as they assess the risks from the conflict.

Brent crude was at USD 73.5 at the time of writing, with an estimated USD 7.5 geopolitical risk premium (compared to J.P. Morgan Economic Research’s estimate of a USD 66 fair value). If the situation remains contained and OPEC+ chooses to increase supply in August to offset any disruptions, oil prices could stabilize. However, if the aforementioned escalations occur, the risk premium could widen rapidly, pushing oil prices over USD 100. For reference, oil prices hit USD 130 during the Russia-Ukraine conflict given Europe’s dependence on Russian energy back then.

Impact on the global economy

The situation remains fluid, and the magnitude of potential economic impact is uncertain. However, the impact is likely to be uneven globally. Asia will be disproportionately impacted, as most oil traffic from the Gulf is destined for Asian markets. For example, nearly 90% of Iran’s oil exports go to China. China has relatively diversified oil import sources and large reserves. However, markets such as India and Indonesia, which rely heavily on Middle Eastern oil, will be more vulnerable. Europe’s demand for LNG has increased since the Russia-Ukraine Conflict, although reliance on the Middle East has fallen as Europe imported more from U.S.. However, they remain highly sensitive to energy prices.

Conversely, the U.S., as a net energy exporter, could be less impacted compared to previous oil crises when it relied more on oil imports. However, the U.S. is entering this period from a vulnerable state of increasing risks of inflation and an economic slowdown. It’s estimated that a USD 10 increase in oil prices could add 0.3-0.4% to inflation, exacerbating current stagflationary risks given the surge in tariffs. This also complicates the Federal Reserve's (Fed) decision-making. We still expect the Fed to be slow to cut rates, as inflation risks remain larger than unemployment concerns for now. 

Investment implications

On June 13th, gold rose 1.4% but retreated on the next trading day. Since the attacks, the U.S. dollar remained stable, while 10-year U.S. Treasury yields actually rose 10 basis points (bps). Equities have been volatile on news headlines, but there has not been a broad-based risk-off reaction in global markets yet.

Within equities, energy and materials sectors, which have underperformed in recent months, could rebound on higher energy prices. Pressure on consumer discretionary is likely to continue due to tariffs and further erosion of disposable income if high energy prices persist. Technology, financials, and healthcare are arguably less impacted by energy prices directly.

For fixed income, in markets that rely on oil imports, the growth risk associated with higher oil prices could be more of a focus for central banks than the inflationary impact, adding to the bias for rate cuts to support growth.

From a portfolio perspective, investors should be prepared for a prolonged period of uncertainty and oil price volatility. Amid high-risk events, investors should maintain investment discipline—review holdings with high valuations and diversify globally—rather than rushing to cash. As seen in Exhibit 1, a stock-bond portfolio tends to outperform cash on a 1-year and 3-year basis after geopolitical crises. Beyond stocks and bonds, alternatives such as global transport may benefit from geopolitical disruptions due to longer trade routes and increased demand for ships.

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