Geopolitical Tensions Drive Oil Prices Higher Amid Middle East Conflict Risks

What happened

Bloomberg Economics Chief Emerging Markets Economist Ziad Daoud warned of a rising risk of renewed fighting between the United States, Israel, and Iran. This outlook has contributed to keeping oil prices elevated, even as energy flows through the Strait of Hormuz recover.

Why it matters

A prolonged conflict in the Middle East region could lead to a long-term stalemate, with significant implications for the global energy market. Geopolitical tensions tend to increase shipping costs, deplete oil stockpiles, and threaten global energy supplies. The importance of the Strait of Hormuz as a vital oil transit route amplifies market sensitivity to any instability in the area. The uncertainty about future supply, even if current flows are normalized, is the primary factor supporting prices.

Market impact

• Interest rates and bonds: In a scenario of increased geopolitical tensions and potential oil price hikes, global inflation could be pushed upwards. This tends to lead central banks to maintain more restrictive monetary policies for longer, or even consider interest rate increases, which would result in higher government bond yields (Treasuries and others). The search for assets considered safer might initially generate some demand for developed country bonds, but inflationary risk tends to prevail in the medium term.
• Dollar and exchange rates: The dollar tends to strengthen during periods of global risk aversion, such as those caused by geopolitical conflicts. Investors seek the safety of the US currency, which can lead to a dollar appreciation against other currencies, including the Brazilian real. Emerging market currencies, in general, tend to depreciate in this context.
• Equities: Stock markets tend to react negatively to geopolitical uncertainties and rising energy costs. Companies with high dependence on oil or facing elevated shipping costs may see their margins squeezed, impacting their profits and, consequently, their stock values. Overall risk aversion also leads to capital withdrawal from riskier assets like equities.
• Commodities: Oil is the most directly affected commodity. Prices tend to remain elevated or rise further due to the perceived supply risk. Other commodities, especially energy-related ones, may follow this trend. Agricultural commodities and metals might have mixed reactions, depending on how inflation and global growth are affected.
• Brazil: Brazil, as a net oil importer in some periods and with its economy sensitive to energy price shocks, can feel the impact in several ways. Domestic inflation may be pressured, requiring a more cautious stance from the Central Bank (Copom) regarding the Selic rate. The real tends to depreciate against the dollar, and the Ibovespa may suffer from global risk aversion and the impact on corporate costs. On the other hand, commodity exporting companies, especially oil, may benefit.

What to watch

Investors should closely monitor diplomatic and military developments in the Middle East region, especially any signs of escalation or de-escalation of tensions between the US, Israel, and Iran. Statements from government and military officials, as well as reports on oil flows in the Strait of Hormuz and global inventory levels, will be crucial for assessing the evolving scenario. Furthermore, the reaction of global central banks to potential inflationary pressure will be a key point of attention.

Scenarios

Base scenario: Tensions remain elevated but without escalating into a large-scale open conflict. Oil prices stay at high levels, with occasional volatility. Global inflation is impacted but in a manageable way by central banks. Risk scenario: The conflict intensifies, leading to significant disruptions in oil supply. Oil prices surge, generating a global inflationary shock and forcing central banks to tighten monetary policy more aggressively, with a negative impact on global economic growth.

Original source: Bloomberg Markets. For information only, not investment advice.