Fast reading
- The conflict in the Middle East has the potential to put upwards pressure on oil prices.
- An oil price shock risks triggering a resurgence in inflation, potentially derailing the easing cycles underway at leading central banks.
- A potential spike in the oil price adds to the sense of uncertainty that has characterised the economic backdrop in recent months.
The eruption in the Iran-Israel conflict over the last week has raised the prospect of a new economic shock that could spark a resurgence in consumer price inflation.
Israel initiated strikes against Iranian nuclear and military facilities on 13 June, and Iran has responded with multiple rounds of missile and drone attacks. The ongoing conflict shows no signs of resolution, and the knock-on effects are unclear.
The price of West Texas Intermediate (WTI) climbed above US$72 a barrel on Sunday, for the first time since February. Traditional safe haven assets such as gold also drew investor attention. Gold was trading around 1% higher on Friday at US$3,426 an ounce, and close to the record high of US$3,500 recorded in April.
“Renewed geopolitical tensions reminded markets late last week that there was more to consider than fiscal policy alone,” says Karen Manna, Portfolio Manager and Investment Director of Fixed Income at Federated Hermes. “What had been setting up as a long summer of waiting for the [US] legislative branches to drive the tone, was shifted quickly to a much broader issue,” she says.
“While inflation seemed to be heading in the correct direction, the possibility of higher oil prices and the lingering question of the timing, degree, and extent of tariff impact continue to drive uncertainty,” she says.
Will oil go higher?
The onset of the conflict led to a spike in the price of oil, but it is not yet clear whether a sustained increase is inevitable.
Research from the European Central Bank (ECB)1 suggests no clear historical relationship between oil prices and geopolitical events. In fact, after many such events, oil prices typically remain weak for several months afterwards.
For example, the price of Brent crude rose by 5% in the aftermath of the 9/11 attacks in 2001 but had dropped by 25% within two weeks. Similarly, prices rose 30% in the two weeks following Russia’s invasion of Ukraine in 2022, but had returned to pre-invasion levels after about two months.
Since the initial spike, oil prices have retreated. The price of WTI was back down to US$71 a barrel on 17 June.
Figure 1: WTI price has shot up (and dipped)
However, the ECB also notes that if the countries involved in a geopolitical event are central to global oil production, the risks to supply could generate significant upward pressure on crude prices.
Sizable volumes of oil flow are shipped through the Strait of Hormuz, which sits between Oman and Iran. In the absence of alternative shipping routes, the strait represents a significant potential chokepoint.
In 2024 and Q1 2025, more than 25% of total global seaborne oil trade flowed through the strait, according to the US Energy Information Administration2.
Maritime traffic has not yet been restricted following the recent upswing in tensions in the region. However, in the event that the embattled regime in Tehran seeks to block or obstruct shipping in the strait, the impact on the oil price could be significant.
Some investors may stick with cash – but it is vulnerable to the whims of inflation
Inflation implications
An oil price shock risks triggering a resurgence in inflation, potentially derailing the rate cutting cycle underway at leading central banks.
The US Federal Reserve has previously noted that the surge in oil prices following the end of the Covid-19 pandemic and Russia’s invasion of Ukraine exerted significant upward pressure on consumer price inflation around the world3.
The battle against inflation has subsequently risen to the top of central banks’ priorities4 and should inflation risk move from ‘persistent’ to ‘resurgent’, it is likely to further complicate an already uncertain economic backdrop.
John Sidawi, Senior Portfolio Manager, Fixed Income, Federated Hermes says the latest bout of market volatility further narrows the range of options for risk-adverse investors.
“The market is teeming with ‘unknowns’ – from punishing trade levies, stubborn inflation, and the prospect of escalating war in the Middle East – leaving investors with the challenge of how to navigate through these periods of high uncertainty,” he says.
“Some investors may stick with cash – but it is vulnerable to the whims of inflation. Gold is renowned for its safe haven characteristics, but it bears no income potential. The US dollar remains the reigning world reserve currency, but it has not been the most effective hedge against volatility as of late,” he says.
“Short duration credit holdings can offer the stability of pure cash, as well as the potential to generate additional income (unlike gold). Amid such high financial uncertainties, short duration holdings can provide a more compelling alternative to traditional safe haven solutions,” Sidawi adds.
For information on Global Short Duration
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