U.S. & Israel vs. Iran: A sharpening geopolitical fault line

On February 28, the U.S. and Israel launched coordinated military operations against Iran, citing the need to neutralize “imminent threats from the Iranian regime.” Iran has since retaliated with missile strikes against U.S. bases and U.S.-aligned targets across the Middle East. The situation remains highly fluid, with outcomes heavily dependent on both the scale and duration of the conflict.

Markets are likely to open risk‑off as investors digest the escalation. Oil prices, already trending higher in recent weeks, have pushed above $70 per barrel, and shipping costs have surged amid mounting concern over potential military disruption. Any further escalation, particularly one that disrupts key energy supply routes or threatens the Strait of Hormuz, would likely have meaningful implications for energy markets and broader global financial conditions.

Geopolitical shocks are inherently difficult to forecast. Although uncertainty can spark sharp market reactions, history suggests that equity sell‑offs driven by geopolitical events are typically short‑lived.

Over the past six decades, most geopolitical crises have led to temporary market drawdowns, with a median peak-to-trough decline of around 7%. Markets have typically needed around three weeks to bottom and another three weeks to recover. After three months, equities have historically been about 4% higher.

The major exception occurs when geopolitical events materially alter economic fundamentals, trigger a policy response from central banks, or coincide with periods of broader macro vulnerability. In this context, oil prices are the most important transmission mechanism from geopolitics to the real economy.

Despite persistent tensions in the Middle East, sustained oil price spikes have been rare. The 2019 Houthi attack on Saudi Arabia’s Abqaiq facility temporarily removed around 5% of global oil supply and sent prices up 15% overnight, yet the move fully reversed within weeks. Similarly, last year’s U.S. strikes on Iran led to a brief 4-5% rise in oil prices, which quickly unwound, with equities rebounding just as rapidly.

From a supply‑demand perspective, oil markets currently appear reasonably well supported. Global supply is running ahead of demand, several Middle Eastern producers increased exports last month, and OPEC+ has agreed to lift production. Inventories, therefore, provide some buffer, though they are leaner than before Russia invaded Ukraine, and spare capacity within OPEC+ remains uneven.

The more acute risk lies in shipping disruptions, not production. The Strait of Hormuz, through which roughly 30% of the world’s seaborne oil supply flows, is a critical chokepoint where Iran has historically exerted significant influence. Oil flows from Saudi Arabia, Iraq, Kuwait, the UAE, Qatar, and Iran itself, with the majority destined for Asia. Even a temporary tightening of the Strait would materially constrain global supply; a sustained closure would be profoundly disruptive. In such a scenario, increased production elsewhere would offer little relief if crude cannot reach end markets.

In a severe downside case, combining a closure of the Strait with broader disruption to Saudi and UAE pipelines, oil prices could plausibly rise above $120 per barrel. The longer such a disruption persisted, the greater the risk of spillovers to global growth and inflation.

That said, while Iran has repeatedly threatened to close the Strait, it has never followed through. Significant domestic constraints, including high inflation, shortages of essential medicines, a deteriorating economic backdrop, and rising social unrest, likely limit Iran’s capacity to sustain a prolonged, high‑intensity conflict.

For now, the global economy appears capable of absorbing a moderate, temporary rise in energy prices. U.S. growth remains robust, capital expenditure is strong, and household energy spending as a share of income is near historic lows. Corporate profit margins also remain elevated, providing a buffer against higher input costs. Europe is enjoying a tentative growth revival, while Asia remains a key engine of global expansion, driven by AI‑related investment, resilient tech exports, and healthy domestic demand.

But fragilities remain. Inflation has eased but remains above central bank targets, and a sustained rise in oil prices would place renewed pressure on consumers while potentially delaying anticipated rate cuts. This is particularly relevant in the U.S., where affordability concerns are already politically and economically sensitive.

Moreover, market sentiment had already softened in recent weeks amid AI‑related uncertainty and valuation concerns weighing on risk appetite. Against this backdrop, a fresh geopolitical shock that pushes oil prices materially higher could amplify volatility. After already absorbing multiple macro and geopolitical shocks this year, risk assets are increasingly vulnerable to negative surprises.

History strongly argues against making dramatic portfolio shifts in response to geopolitical events. While our constructive medium‑term macro outlook remains intact, the unpredictability of the current episode reinforces the importance of diversification and resilience.

Portfolios should remain positioned for continued global growth, but with sufficient exposure to assets that tend to perform well during periods of heightened risk aversion. These include gold, government‑backed securities, and selective commodity exposure. In addition, sectors that typically benefit from elevated geopolitical tensions, such as defence and aerospace, can help mitigate downside risk.

In an increasingly fragmented and volatile global order, disciplined diversification remains one of the most effective tools investors have to navigate uncertainty while staying aligned with long‑term objectives.