Oil: The return of risk premium

While there are still threats of an escalation, the oil market so far remains spared from major impacts. On top, ample storage and plentiful spare capacity bolster oil’s supply resilience. While oil prices saw a spike, the long-term trends are very likely unscathed by the events in the Middle East. The oil market remains on a twisted road to abundance, which should pressure prices back down. We believe that we are still amid a temporary oil price bounce, with a risk premium lifting prices for weeks rather than months.

Both sides will eventually near a level of exhaustion of military resources, which points at a short duration. The extent of the damage done to Iran’s nuclear programme is somewhat unknown, but important for any negotiations and outcome. The price reaction so far seems surprisingly unemotional, not least given that the Israel-Iran war was among the key wild cards for oil. One explanation is the resilience of today’s oil market. Storage is ample in the Western world and especially in China. Saudi Arabia, Kuwait, and the Emirates also have plentiful spare capacity, exceeding 5% of global output, which they have just begun to bring back to the market as well.

Equity markets: Muted response so far

Despite heightened geopolitical tensions in the Middle East following Israel’s military actions last week, equity markets have displayed a surprisingly measured response. Since the onset of the strikes last Friday, the S&P 500 declined only modestly, underscoring the market’s current assessment that the risks to global energy supply chains remain limited.

In this context, the standard geopolitical playbook for equities continues to apply: a sharp but brief sell-off in response to the shock, followed by a relatively swift rebound. For markets, the rate of change in geopolitical developments often matters more than the absolute level of risk. So long as escalation remains contained or evolves gradually, equities tend to look through the noise. That said, the situation remains highly fluid. A broader regional conflict cannot be ruled out, and investors are closely watching for any catalyst that might disrupt the stability of energy markets or global risk appetite. 

Gold: A moderate reaction to the Israel-Iran war

The gold market’s reaction to the conflict between Israel and Iran has been very moderate. Barring a severe economic impact or a spreading in the region, it should not lastingly lift prices. That said, the fundamental backdrop for gold is still favourable, and we reiterate our Constructive view.   

While the conflict between Israel and Iran continues to hit the headlines, gold prices have returned to the level before the initial attack. We assume that gold’s temporary rise, which was very moderate, had been driven by some speculators and automated trading systems in the futures market rather than by physical safe-haven demand. At first sight, this moderate reaction may be surprising, considering the potential consequences of the conflict and also the typical skittishness of the more short-term-oriented traders in the market. But a closer look suggests that it is in line with the historical pattern of such geopolitical shocks not lastingly lifting gold prices.

Economics: Marginal impact on inflation and monetary policy 

Given that oil prices should moderate after a temporary spike, the impact on inflation should remain marginal and not alter the outlook for monetary policy easing this year.  From an economic perspective, the question on whether the conflict increases inflationary risks and delays central bank monetary policy easing is at centre stage. 

Given our base case that the war will not impact oil deliveries through the Strait of Hormuz, rendering the current oil price spike temporary, the inflationary impact will remain marginal. Accordingly, inflation risks from oil prices were not a key topic in the statements of the various central banks that met this week, such as the US Fed, the Bank of Japan, the Bank of England, or the Swiss National Bank. We therefore do not change our broader outlook on monetary policy for the remainder of this year.

Bond markets: Looking through geopolitics

The bond market is looking through the increased geopolitical tensions, with yields remaining stable and credit spreads barely moving. At the current level of escalation, we do not expect geopolitical tensions to be a major market driver. From a bond market perspective, bond markets are looking through the increased tensions, as yields remained pretty stable and credit spreads barely moved. As a result, at the current escalation level, we do not expect geopolitical tensions to become a major market driver. 

Looking at the initial reaction of US Treasury yields on Friday 13 June, after the first Israeli attacks on Iran were reported, is quite telling: following a minor dip in yields, which corresponds to the more usual safe-haven/risk-off sentiment pattern, US Treasury yields actually started to increase again. With the focus on the inflationary impact of higher oil prices, we believe that the most important piece of information for bond markets this month is actually the full package of central bank updates.

What does this mean for investors?

Investors have come to understand what the often-cited ‘multi-polar world’ truly means for them. In a multipolar world, the threshold for entering a war has been lowered, as the Ukraine war and the latest escalation in the Middle East demonstrate. The next moves in the Israel-Iran conflict will tell. We still believe there is a fair chance that the conflict will follow the usual geopolitical playbook, that said, an actor feeling cornered in a conflict can still pose a serious risk of making an irrational, or even self-defeating move.

Given the highly volatile mix in the current situation, we recommend investors to remain vigilant and wait for real signs of de-escalation. This might manifest as more symbolic than impactful retaliation, accompanied by an emphasis on diplomacy. If this occurs, redeploying cash will be the order of the day, with Europe likely to benefit the most in a global economy no longer threatened by a sustained oil shock.

Find out more about the current investment environment in our Market Outlook Mid-Year 2025.