The turbulence in the Middle East has affected the markets, especially due to the energy price impact resulting from the almost complete closure of the Strait of Hormuz. If prolonged, the rise in the energy price could accelerate inflation, thus weakening consumers’ purchasing power and, ultimately, economic growth.
Tensions in the Middle East continue to tighten for the third week running. The markets have not experienced significant panic, but nevertheless, the valuations of equities have fallen somewhat. Interest rates have risen, which has eroded high-duration investments’ returns. Credit spreads have shown a slight upward trend.
The crisis has caused the greatest upheaval in the markets that had the best returns at the start of the year, such as Japan, Europe and the emerging markets. This is influenced by the lack of energy self-sufficiency and the return of stock markets to themes that are better suited to an uncertain world.
Currently, it appears that the crisis’s most pronounced market impacts stem from energy prices, for example due to the sharp rise in the oil price in recent weeks. However, an examination of futures prices indicates that the prices for oil deliveries in the near future are higher than for deliveries occurring later in the future. The market consensus seems to be that the crisis will not last very long and the negative effects will mainly impact deliveries made in the near future.
Although oil futures prices seem to be turning downward in the long term, the markets are pricing in a higher price level than at the onset of the crisis. While oil futures prices were around 60 dollars per barrel before the situation escalated, longer-term forecasts expect them to remain at a minimum of about 70 dollars.
Oil availability problems are currently not related to production issues. For the time being, enough oil is being produced globally, but the problem lies in logistics. This challenge is harder to overcome, given the lack of alternative routes to the Strait of Hormuz. The energy challenges are not limited to oil, however, as a significant proportion of natural gas – especially critical for Europe – also passes through the Strait of Hormuz.
To ease the situation, different countries have released their oil reserves in varying amounts. However, the issue is that they cannot be fully utilised all at once, as there is a fear that the crisis will be prolonged or escalate even further. Oil reserves are also relatively small compared to the daily volumes passing through the Strait of Hormuz – the reserves account for only 5–10 per cent of the amount currently not being delivered.
Right now, the most positive news for the markets would be peace between Iran, the United States and Israel, which does not seem to be the most likely prospect, however. The markets consider the most likely scenario to be the cooling of the most acute crisis, even if peace is not actually achieved.
The most significant long-term potential effects of the crisis are especially tied to inflation, which is expected to rise due to the spike in the oil price. If the price of oil were to remain at its current level, it would raise inflation to three per cent.
A significant share of fertilizers used globally in food cultivation, for example, also pass through the Strait of Hormuz. If the crisis prolongs and fertilizers are not available, food production could also be affected. This, in turn, would raise food prices and thus accelerate inflation.
Notably, the acceleration of inflation is seen as one of the biggest threats to the US President Donald Trump, considering his aggressive push to lower the key interest rate and improve consumers’ purchasing power. With just over six months until the midterm elections, which are critical to the Republicans, rising inflation could threaten to erode the party’s support.
While the economic data does not yet reflect the events of the last few weeks, the recently published figures reveal the situation that set the stage for the turbulence. The situation seems to be reasonably good, although not entirely optimal.
In Europe, the data has mainly deteriorated, as figures depicting industrial production and consumer confidence have declined. In China, on the other hand, the situation has been improving.
In the United States, housing market data has developed positively, and PMIs have also been strong. The GDP and growth figures reported for the last quarter of the year were surprisingly weak, nevertheless. Partly, this was influenced by the decrease in public spending due to the US government shutdown. The share of private consumption was also weak, partly because of the government shutdown, as it reduced the wealth available to consumers and thus their consumption possibilities.
The data reported from the labour market in recent months has been varied. The latest figures for off-farm employment fell significantly compared to the previous month when more new jobs were created than expected. If the labour market were to weaken in the long term, it would pose challenges for both the United States and the global economy due to a decline in private consumption.
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