What the Israel-Iran war means for markets

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You don't need to be a super smart geopolitical strategist these days to see that the situation in the Middle East is pretty grim.

It's all very fluid, stuff is changing quite quickly, and we humble markets monkeys of the Unhedged podcast know our limits.

We are not here to give you a read on what happens next between Israel, Iran and the US.

What we can do though is unpack what this all means for the global economy and for global markets.

Is that all more important than the human lives at risk here?

Obviously not.

But geopolitical shocks, especially in the Middle East, can have ripple effects to jobs, livelihoods and prosperity around the rest of the world.

And that's the bit that we can help you understand.

Today on the show, we're all freaking out.

Why are the markets not freaking out?

This is Unhedged, the markets and finance podcast from the Financial Times and Pushkin.

I'm Katie Martin, a markets columnist here at FT Towers in quite hot and stuffy London, finally shaking off my hot and stuffy cold.

And I'm joined down the line from New York City by fellow markets monkey, alpha primate of the Unhedged newsletter, Rob Armstrong.

Rob, stop that.

That was my alpha monkey noise.

I gather from the last podcast that you were long short shorts.

So if it's not too personal a question, I would like to ask you, are you sporting short trousers today?

No, I have big boy pants on right now.

I do not, I'm not a shorts at work kind of a person.

Shorts are for the weekend and the weekend only.

Where do you stand on linen suits?

I don't like wrinkles.

I like linen in principle, but in practice, it seems like a lot of ironing, and you'd like have to take an iron to work to do a quick midday ironing.

You're possibly overthinking this.

Yeah, so no, the answer is no on linency.

It's a relief for us all.

Now, our vibe, right?

Our whole thing on this podcast is kind of loose, kind of light-hearted, very markets focused.

I just want to state for the record that we are not terrible people.

We care about what's going on in the Middle East.

Obviously, the important thing about this situation is the civilians who are caught in the crossfire here.

And the people of Iran and the people of Israel are what matters here, is the human beings.

We are a tiny little sideshow to that, which is called, what does this mean for markets?

Yep.

And markets are like very dispassionate, right?

They don't care about your feelings.

They sort of, in a way, don't care about human beings.

They don't care if you live or die.

Yeah, in most cases.

Yep.

Yep.

So listeners, don't judge us, but we're going to get stuck in.

So matters have gone from bad to worse between Israel and Iran.

There are rockets flying in both directions.

What has the market reaction been, Rob?

Well, the most striking thing is that oil hasn't moved very much.

It's moved a bit.

It's jiggled around.

Let me call up an oil price chart here.

I should have this in front of me.

I can save you the bother.

Okay, please.

So save me the bother.

There was a big jump in the price of oil, which is pretty much what you would expect from an escalation of Middle East tensions because Iran is an oil producer.

So the price rushed higher, like by 12%,

but it's calmed down a lot since then.

And we're still now only at about $73 a barrel for Brent.

That's higher than it was, but it's the highest since, ooh, April.

Yeah.

Like it's not a huge move.

And if you compare it to Russia's full-scale invasion of Ukraine in 2022, then you saw oil go to $110 a barrel, like in a pretty straight line.

And that was much more dramatic.

Now, you know, I'm old enough to remember that tension with Iran was one of those things that had a really meaningful impact on oil prices.

Like, why is that just not happening now in that old school way?

There is a bunch of reasons.

And the most important is probably that since we were wee little market analysts in the 1970s.

Speak for yourself, I'm strong.

The United States has emerged as the global energy superpower.

I mean, these, every time I look at these numbers, they amaze me.

So

let's look at top producers of oil

worldwide.

United States, this is 2023.

This is from the Energy Information Administration of the United States.

22 million barrels a day, United United States.

That's more than a fifth of the world total, and it's twice as much as Saudi Arabia.

I mean, I just can't get my head around that.

America produces not only more oil than Saudi Arabia, way more oil, to say nothing of Iran, with 4% of the world supply coming from Iran.

So 4% matters.

If that 4% disappears from the world market, that price is going to move.

But,

you know, this ain't the 70s.

And on the natural gas side, the stats are roughly analogous.

America, the world leader,

and the rest of the world kind of bringing up the tail.

Yeah.

Now, as we chat here on Tuesday afternoon, the other thing is that

Iran's still pumping, right?

Correct.

So it's not as important a part of the global market as it once was.

And right now, who knows if this will still be true by the time the podcast runs, but it's still flowing, right?

So again, that just means that there's just not that much reason to really panic.

This is an area where I will plead ignorance.

A dynamic that I simply don't understand

is that the Israelis and the Iranians seem to be having this war in which there is a tacit agreement about how far each side will go.

And I don't know how that works out or what the rules of that are and

when each side breaks the tacit agreement, or whatever, totally above my pay grade.

But one part of the agreement seems to be that Israel has decided it will attack Iran's domestic energy infrastructure.

In other words, it will make it a pain for Iranians to get a hold of Iranian gasoline and Iranian oil.

They will not attack the export facilities, most prominently on this place called Karg Island, which is where most of the Iranian oil comes out of.

And what a lot of people said to me when I was trying to call around and figure out what was going on in the last couple of days is

if Israel decides it will attack those facilities,

the export facilities, then the war has reached a very, very different level because then you're just cutting off the economic lifeblood of the country and it's an existential issue for Iran.

And then who knows what the Iranians will do in response?

They are totally unrestrained at that point because they have nothing to lose.

The other thing that Iran can do is shut the Strait of Hormuz, right, which would be a kind of putting a cork in a lot of global energy supply.

Again,

at the time that we're recording this, this is not the case right now.

So for now.

That's their side of the things they've decided not to do.

Israel is implicitly saying, we're not going to destroy your export facilities.

Iran is implicitly saying, we're not going to mine the Stray of Hormuz, which then gets everybody involved and it's a big, hairy, nasty, unpleasant regional conflict rather than a war between Iran and Israel, which is serious enough.

But if you get the Saudis involved, whoo boy, you know, it's on.

Then it's a whole different kettle of fish.

But for now, for as long as you've got oil trading in the kind of low 70s on the Brent benchmark.

So we did have, just like we had the spike in the oil price price when things first got really hairy recently, we did see a bit of a step back in stock markets globally.

But again, nothing too dramatic, really.

So if you look at markets, you really wouldn't know there was anything happening here most of the time.

And this is part of a larger phenomenon that we come around to, is the incredible resilience.

of global equity markets in the face of first the trade war and now a war in the Middle East.

The dip is just getting bought in most cases, regardless.

And there's a kind of general question to ask is whether that is a phenomenon of euphoria or rationality.

Yeah.

And I bet I know which side you're on, Katie.

No, you bet wrong.

I am fully in the I don't know how this is going to pan out campaign.

But I do know if you look at some of the analysis from

investment banks, you can sketch out a world where the oil price rockets to like $120 $120 a barrel, depending on what kind of clampdowns come from both sides of this conflict, from

Iranian side and from the Israeli side.

But you can also sketch out a world in which we fall back to the even lower 70s and it's really like nothing has happened.

So that's the difficult thing for investors and for the rest of us, is that we're sort of staring down the barrel of this world where the oil price could go crazy or it could do nothing.

And markets are all about uncertainty and not having a perfect perfect vision of the future.

But that seems like quite binary and quite scary and not a perfect time for markets given that we've already got lots of other bits of uncertainty out there.

So this is very unhelpful for investors.

Katie, you give me a wonderful opportunity to roll out my favorite Wall Street cliché,

which is tail risks.

Just saying that phrase makes me feel like I'm a smart person.

Oh, you got to think about the tail risks.

And, you know, the gag here is, yeah, the central case is that this remains a contained regional conflict and everybody gets talked down off the ledge and nothing really happens.

But if one of the things we described earlier starts happening, mining of the strait, bombing of Carg Island, regional conflagration, then suddenly you have a tail event.

Again, Robert feels smart because he said the word tail event.

And so a reader of the column, Michael Chin of Allocation Strategy, sent me a really interesting chart, which is a chart of the options implied probabilities of a big jump in the oil price.

And he reckons on the basis of his

work on options that the probability of a 10% or greater increase in the price of oil is 17%,

which is a much thicker tail than you usually.

So one in five chance, basically, the market is saying we're going to see a pop somewhere here of $10 or more.

And if you go up $10 all at once.

I guess it's probably worth talking about, though, Katie, why

the oil price did go up so much in the Ukraine war, the Russian invasion of Ukraine.

And that did seem to have a big effect on the price.

Because

Russia is such a huge supplier, particularly

to Europe, or at least was.

And

we're still working through that process of figuring out how Europe can survive long term

without Russian oil.

I mean, there is a reasonable possibility that the oil price just kind of roofs it one day and heads up to $110, $120.

And then we have a shock on.

And then we have a shock on.

And then central banks around the world have to give it a think.

If suddenly the oil price is much higher, oil and inflation are famously connected, and it's debated territory exactly how central banks should respond to oil price shocks, but they got to start thinking because if people start, if inflation expectations start to take off in the face of a much higher oil price and people start getting jumpy,

then you're in a bad situation as a central banker or indeed as a human being.

And some,

I should note, by the way, that some central bankers are also human beings.

Some of them.

But

some of them.

Anyway,

because an oil shock both slows growth and increases inflation, right?

So you're getting it from both ends of your mandate.

Central banker is supposed to keep employment high and keep inflation low.

Well, the American ones are anyway, yeah.

Yeah, yeah, I'm sorry.

The American one is.

So suddenly, if you have an oil price shock, the American American central bank is getting it from both sides of its mandate, and they have a problem on their hands.

Yeah, not helpful, because all things being equal, that means higher inflation, which means higher interest rates, which is very much against the run of play.

So the oil price is not screaming in alarm here.

But if you look at other bits of the markets, you can see some quite interesting patterns.

I will come back to my favourite point, which is that the dollar and US government bonds are not really responding in a kind of nervy way right now.

Maybe that's because holders of those assets are not nervous, but maybe it's because some of the use of fear as a driving force in pushing the dollar and US government bonds higher has reduced recently.

Yeah, so the flight to safety trade, your view is that the flight to safety trade in the dollar and dollar assets is not what it once was.

No, it's a little bit different because you can see some signs of nerves.

If you look at gold, it's up a bit.

The prices near records were about $3,390.

That's just an amazing price.

We had a really interesting big read on our pages just the other day from Ian Smith and Leslie Hook about how gold has overtaken the Euro as the second most important reserve asset for central banks.

Big holders of kind of government or quasi-government money around the world do appear to be edging out of the dollar and putting a lot more of that to work in gold instead as a kind kind of safe hidey hole.

Bloomberg had a news story the other day that struck me, Katie, which was, it was basically an interview with a currency trader at a big bank.

And you know, what currency traders do a lot at big banks is they help importers settle their accounts when they bring stuff into the United States.

And this banker was saying, more and more of my importers don't want to settle.

their trades in America in dollars.

They want to settle in Euros or in Chinese currency or whatever.

And this is a big change.

Now, these stories are slightly a dime a dozen in the sense that banker says thing.

You know, it's anecdotal evidence.

But I was still, I was struck by the color of that, that there is something going on here.

We've strayed away from oil and into the dollar, but these things are going on at the same time.

We have a disturbance in the oil universe at a time when things were already changing in the dollar universe.

And so the way they interact is particularly interesting right now.

Yeah, there has been a disturbance in the force.

I think that we are going to see the Euro playing a much bigger role in global trade from here.

But also, if you're looking for signs that markets are a little bit nervous and the oil price is not doing it for you, you have got gold that's up near record highs.

You've got the Swiss franc, which shot up around the Liberation Day, super crazy US tariffs announcements at the beginning of April, and it's stayed up.

So the Swiss franc is one of those currencies that people really like to buy and hold when they're nervous about stuff.

So it's there.

Markets are kind of nervous.

And I think investors have got themselves to the place where

if things go really pear-shaped really quickly in Iran, then they can jump on that.

They're kind of

ready.

But right now,

there's just no reason to really freak out, which I know is kind of, again, very surprising.

Inhumane in some way.

Yes, yes.

But that's markets for you, I'm afraid.

This is the business we've chosen, Katie.

Godfather.

This is the business we've chosen.

So who would want to be Jay Powell in this situation?

Yeah, that's a great challenge.

We've got a rates decision coming up from the Fed a little bit later this week.

The other day, Donald Trump called Jay Powell a numbskull for not cutting interest rates as quickly or as hard as he would like.

Yes, to which Jay Powell responded, sticks and stones may break my bones.

So no, no, no, no, no.

A very dignified silence from the Fed on this.

And really, what can you say to that?

I can tell you what Jay Powell is going to say at his press conference later this week.

The oil price is scaring people a little bit.

It could go up at any time.

What are you going to do?

And the summary of what big game Jay Powell is going to say is: we're going to watch this situation very closely.

Yes.

And the question from the journalist is also going to be: Donald Trump says you're a numskull.

What do you say to that?

Are you, in fact, a numskull?

Really?

What do you say?

I know you must get asked this a lot.

Maybe you could give him some space on

what to say.

Deny, deny, deny.

We live in extremely childish times.

and very much along those lines.

We will be back in just a little moment with Long Short.

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Okey-doke, listeners, it's time for Long Short, that part of the show where we go long, a thing we love, or short, a thing we hate.

Rob, whatcha got?

I am long New York City Pizza, Katie.

Oh.

My wife had a bunch of her friends in town from the West Coast, and sometimes in New York because we're spoiled, we forget how good the pizza is here.

But we ordered from our local Luigi's, and we had pizza.

And these friends from California were in ecstasy at how much better the pizza is here than out there.

I've never seen four happier people in my life.

So we still got it.

Was there lots of Lady Petrel involved in this gathering of friends?

Lady Petrel?

Lady Petrel is like cheap booze.

Oh, yeah.

I'm long Lady Petrol too.

I am long Trump Mobile.

You know, these $500 gold phones.

I just, I, you know, just lay it all out there.

I just, I admire it.

And I think anything that people can do to advertise their Trump fanboy or fangirl credentials makes them easier to identify and either avoid or cozy up to, depending on your worldview.

So, I'm all in favor of people waving around ridiculous gold phones

with trucks written on them.

Strongly agree.

Strong agree.

Now, listeners, we are not going to be back in your ears on Thursday because the US is out for Juneteenth, the annual celebration and commemoration of the end of slavery.

Americans, enjoy your holiday.

Everyone else, we will be back on Tuesday.

Until then, it's muggy out out there.

Stay cool.

Choose light fabrics.

Unhedged is produced by Jake Harper and edited by Brian Erstak.

Our executive producer is Jacob Goldstein.

We had additional help from Topa Forge.

Cheryl Brumley is the FT's global head of audio.

Special thanks to Laura Clark, Alistair Mackey, Greta Cohn, and Natalie Seidler.

FT Premium subscribers can get the Unhedged newsletter for free.

A 30-day free trial is available to everyone else.

Just go to ft.com/slash unhedged offer.

I'm Katie Martin.

Thanks for listening.