Siri – Find Me an Off-ramp!! - Global market update

Anyone born in Ireland over the last 30 years really will have no idea how arduous long distance road travel in this country used to be. When summer-time came and the car was loaded up for a holiday in the West of Ireland, or heaven forbid far- flung places like Cork and Kerry, the prospect of a five- or six-hour drive before you started to enjoy your holiday would fill most people with dread. But then, thanks in no small part to lots of structural funding from the European Union, the motorway network in this country was born. Great and all as this development has been, driving on a motorway does have one downside – miss your turn-off and you will likely have to go another 20-plus miles down the road before the next off-ramp gives you the chance to get back to your intended route. The US Administration is now in a similar predicament when it comes to its “excursion” (it’s not being called a war by the President anymore) in Iran – a short campaign is turning into a much longer and more expensive journey than anyone planned and one that can’t be reversed by the stroke of a pen!

We are now over three weeks into this war and while it may have produced regime change, it has done so in the worst possible way. Former clerical leader Ali Khamenei was 86 and had survived multiple bouts of prostate cancer. His death in the coming years would likely have triggered a real internal reckoning in Iran, potentially opening the door to somewhat more pragmatic leadership, especially after the protests and crackdown earlier this year. Instead, the regime made its most consequential decision under existential external threat – giving the hardliners a clear upper hand. Now we appear to have a successor who is 30 years younger, deeply tied to the elite military (IRGC) and radicalised by the war itself – including the killing of family members.

Many have modelled the impact of the closing of the Strait of Hormuz for 4–10 weeks, with 1–3 years required to restore oil production when factoring in infrastructure damage, and the result on oil prices could be a spike from around $65 to $175–200 per barrel before eventually settling in the $80–100 range a year later in a new normal. Iran is still moving oil through the Strait of Hormuz while remaining capable of harassing global shipping and preventing others from exporting their crude. Attacks on natural gas infrastructure in neighbouring Gulf states are also impacting the price and availability of that commodity.

The US and Israel have overwhelming military dominance and are exacting a tremendous cost, but Iran doesn’t need to win battles. It just needs occasional successes – a small boat hitting a tanker; a drone slipping through defences in the Gulf; a strike on a hotel or oil facility. Each 

incident creates insecurity and drives costs up while reminding everyone that the regime is surviving and fighting.

The Trump Administration is considering plans to blockade or occupy Iran’s Kharg Island to take Iran’s ability to export oil off the map and try to coerce it to open up the Strait of Hormuz or even end the war. This would be a potentially costly ground operation with no guarantees of a successful outcome – the Iranian government only has to survive to win and can probably do that even without Kharg.

The move in the oil price and the wider commodity environment has brought with it an increase in the level of conversations around the future path of inflation globally. Not surprisingly with eight major central banks meeting last week, this was a topic high on the agenda.

The European Central Bank (ECB) is in as good a place, as one might hope given the large negative supply shock that stems from military operations around the Persian Gulf. Inflation expectations seem well anchored, which affords the Central Bank time to assess the nature and consequences of the shock. Decelerating wage growth and a marginally loosening labour market should reduce fears of the inevitable rise in headline inflation automatically spreading through the economy. That said, the President of the ECB gave three triggers for a potential decision to hike policy rates: (1) the intensity of the supply shock caused by the conflict in Iran; (2) its duration; and (3) the propagation of the shock through the economy in the form of “second round” effects. Over the next couple of quarters, the emphasis will be on the first two.

The Bank of England (BoE) held rates at 3.7% in a distinctly hawkish meeting that signalled a break away from its previously dovish bias. The shift in tone is justified, but the underlying message is more nuanced – contrasting a domestically weak economy against a stagflationary shock that leaves the future direction of policy unclear and path-dependent. The clear message was that the bank is ready to act if necessary. However, the route to doing so is path-dependent and tied to unpredictable geopolitical developments. The meeting triggered a sharp market reaction, with a dramatic repricing of end-2026 rates, even though the bank’s underlying message suggested a preference to hold and wait for more information on the Middle East shock.

Let’s hope the off-ramp comes soon or we could feel like we are in a re-run of the National Lampoon’s Summer Vacation!!