Oil Surges Nearly 20% in Month Amid Escalating Middle East Tensions

What happened

Brent and WTI crude oil futures saw sharp increases in October, marking the fourth consecutive month of gains. Brent crude for January delivery rose 19.25% for the month, closing at US$ 113.43 per barrel, while WTI for December advanced 17.79%, settling at US$ 104.12 per barrel. This significant appreciation was primarily driven by investor fears of a new escalation of hostilities in the Middle East, involving the United States, Israel, and Iran, especially after the US midterm elections scheduled for November 3. Recent attacks in the Strait of Hormuz also contributed to the increased risk premium for the commodity.

The market is attentive to statements from US President Donald Trump, who has repeatedly threatened to resume airstrikes against Iran after the elections. On Thursday, a senior military commander reportedly presented Trump with options for action, according to The Wall Street Journal. Furthermore, Houthi activity and their territorial gains near Bab al-Mandab continue to threaten navigation and alternative export routes for Saudi Arabia. Attacks on tankers in the Strait of Hormuz, attributed to Iran-linked groups or other parties, keep the market on high alert, with Iran's Revolutionary Guard Navy reporting today that three oil tankers caught fire and exploded while attempting to use what it described as unauthorized routes in the Strait.

Why it matters

The rise in oil prices is a critical indicator of geopolitical instability and has direct implications for the global economy. The Middle East region is crucial for the world's energy supply, and any disruption or threat to navigation in strategic points like the Strait of Hormuz can significantly impact global supply. Increased commodity prices raise production and transportation costs across various industries, potentially generating inflationary pressures at a time when many central banks, including the Fed, are already grappling with price control challenges. Uncertainty surrounding US foreign policy after the midterms adds a layer of complexity, suggesting that the risk scenario could deteriorate further.

Market impact

• Interest rates and bonds: Rising oil prices tend to increase inflation expectations. This could lead central banks to adopt a more hawkish stance or maintain high interest rates for longer to curb inflationary pressure. Consequently, government bond yields (Treasuries) may rise, reflecting expectations of higher interest rates and an increased risk premium.
• Dollar and exchange rates: In times of heightened geopolitical uncertainty and rising oil prices, the US dollar tends to strengthen as a safe-haven asset. Emerging market currencies, including the Brazilian real, may depreciate against the dollar, especially those from oil-importing economies or those more sensitive to external shocks.
• Equities: Increased energy costs can negatively impact corporate profit margins, particularly for companies in the transportation, manufacturing, and consumer sectors. This tends to put downward pressure on stock markets. However, energy sector companies may benefit from higher oil prices, mitigating some of the overall decline.
• Commodities: Beyond oil, other commodities may be affected. Gold, for example, tends to appreciate as a safe haven during periods of uncertainty. Agricultural commodities and industrial metals may see mixed movements, depending on the perceived impact on global demand and production costs.
• Brazil: For Brazil, higher oil prices have a mixed effect. On one hand, Petrobras, as a major producer, tends to benefit, which could boost the Ibovespa. On the other hand, rising fuel prices could fuel domestic inflation and pressure the exchange rate, requiring a response from the Central Bank (Copom) and potentially limiting room for Selic rate cuts or even forcing a more cautious stance.

What to watch

Key upcoming events include the US midterm elections on November 3, which could shape the direction of US foreign policy regarding Iran. Furthermore, it will be crucial to monitor any developments in the attacks in the Strait of Hormuz and Houthi activities, as well as statements from Iranian and US officials. Global inflation data and monetary policy decisions from major central banks will also be important to assess the secondary impact of rising oil prices.

Scenarios

Base Scenario: Geopolitical tensions in the Middle East remain elevated, maintaining the oil risk premium. Prices stabilize at higher levels, and global inflation feels the impact, leading central banks to maintain a cautious stance. Risk Scenario: A significant military escalation after the US midterms leads to oil supply disruptions, with prices surging even further. This triggers strong global inflationary pressure and an increase in risk aversion, with negative impacts on equities and emerging market currencies.

Original source: Valor Econômico. For information only, not investment advice.