Since Saturday, Israel and the US have been attacking Iran from the air with Iran firing back with missiles and drones against targets throughout the Middle East. Iran has also effectively closed ship traffic through the Strait of Hormuz which removes a significant share of seaborne oil, oil products and natural gas from the global market. Spot crude oil prices have increased close to 20% in USD terms, while European natural gas prices are up by more than 50%. Given the scale of the disruption, we see this price reaction as modest and also note that markets expect spot prices to decline again in coming months. The relatively modest reaction likely reflects that this is happening at a time when the global economy is relatively balanced as witnessed by the low and stable inflation and unemployment we are seeing in major economies and in contrast to the situation in 2021-2022.
Another reason for the relative calm in energy markets is likely that markets expect the war to be short, either because the US and Israel will reach their objectives or because they will choose to stop for political and economic reasons. This means that there is a risk of significant further price increases if the war lasts longer. The most important aspect to watch in this regard is likely to be the Hormuz Strait traffic. If that can be resumed, it will sharply reduce the disruption to energy markets, even if the conflict continues in other areas.
A similar risk applies to broader financial markets. There have been modest declines in equity prices especially in Europe, which unlike the US is a big net importer of oil and gas. Similarly, there has been a modest strengthening of USD. In bond markets, there has been noticeable increases in especially short-term yields as there appears to be fears that the ECB might hike interest rates in case of a more prolonged conflict and that the Federal Reserve could postpone or cancel the rate cuts expected this year. The argument is that high energy prices add to inflation. However, in the current macro environment we see it as more likely that central banks will take the textbook approach and not react to the supply chock, unless it starts to affect inflation expectations. Like in energy markets, we see a risk that the reaction becomes much more pronounced in financial markets in general if the conflict broadens or drags out.
In the euro area, inflation surprised to the upside at 1.9% y/y in February with a rebound in core inflation to 2.4% y/y. Unemployment declined to a record low 6.1% in January. Hence, the data is also slightly supportive of higher yields.
China has lowered its official economic growth target from 5% to a range of 4½-5% in line with previous signals. Higher growth in household consumption is stated as a top priority but there is little in the way of new policies to achieve this, and we see it as likely that exports and investments will have to continue to drive demand, not least because the housing market remains very weak.
The most important factor to watch in the coming week is the war and especially the Hormuz Strait traffic. However, we also get US CPI inflation for February which likely was lifted by energy prices also before the attack but with core inflation held down by housing rents.
