Yesterday’s sharp rise in oil prices was the market’s reaction to a renewed escalation of tensions in the Middle East. Brent crude rose by around 6% and ended the session near USD 113 per barrel, bringing its increase since the start of the war to 57%. The exchange of fire between the United States and Iran showed how fragile the current ceasefire may be. Markets interpreted the events as a signal that the conflict could once again enter a more active phase. Such information has an immediate effect, with investors quickly raising the risk premium. This is particularly important after weeks of rising equity prices, during which markets had partly ignored the risk of renewed escalation.
The US military yesterday repelled Iranian drone and missile attacks while escorting two ships through the Strait of Hormuz. The escalation also involved the United Arab Emirates, which reported intercepting Iranian missiles. An Iranian drone was also said to have caused a major fire at the port of Fujairah. In addition, the UAE issued missile alerts to residents for the first time since the ceasefire began. This was a significant exchange of blows at a time when investors had been expecting a gradual easing of tensions.
Equity markets also came under pressure. Technology stocks suffered the smallest losses, supported by strong financial results. The Nasdaq fell by 0.19%, the S&P 500 lost 0.41%, and the industrial Dow Jones declined by 1.13%. The Polish market also felt the effects of global turbulence, although the reaction of the WIG20 was calm. The index rose by 0.11%, showing that local investors did not respond with a sharp sell-off.
The rise in oil prices is also increasingly affecting the bond market. The yield on 30-year US Treasuries exceeded 5% for the first time since July last year. Investors have begun pricing in the risk that the Federal Reserve may not only postpone interest rate cuts, but could even be forced to raise rates again. The market is now pricing in around a 70% probability of a Fed rate hike within the next year, a major shift from expectations before the conflict began, when investors had assumed a series of cuts. This shows that oil is no longer merely a commodity market issue. More expensive energy changes the path of inflation, and therefore the path of interest rates. In such an environment, central banks have less and less room to ease policy, as each new wave of fuel price increases may quickly feed into inflation expectations.
The current situation is difficult for markets. US commanders yesterday avoided giving a clear answer as to whether the ceasefire had formally been broken. Iran, for its part, claims that talks with the United States are making progress, while at the same time warning Washington and the UAE against being drawn back into the conflict. In these circumstances, market stabilisation may be difficult to achieve. Every new piece of information can change the pricing of oil, equities, bonds and currencies within minutes. This is especially true as Donald Trump yesterday also presented the “Freedom Project”, a plan to help move trapped ships out of the Persian Gulf, which could become another source of tension.
The main point of dispute remains the Strait of Hormuz. Iran is blocking most maritime traffic and is making the reopening of the strait conditional on the United States lifting its blockade of Iranian ports. In this arrangement, energy becomes an important negotiating tool. It is no longer merely a commodity whose price is determined by the balance of supply and demand.
At present, the most likely scenario remains a prolonged conflict with periodic clashes and persistently high oil prices. This is a particularly uncomfortable scenario for investors, as it extends the period of heightened uncertainty. There is no full-scale war, but there is also no peace that would allow the risk premium to decline. Instead, there is an intermediate state in which the market lives from one statement to the next, while oil and gas prices remain vulnerable to sharp moves.
