US Strikes on Iran Escalate Middle East Conflict

In focus today

The conflict between Israel and Iran has now entered its second week. In a major escalation termed “Operation Midnight Hammer”, the US joined the battle early Sunday morning, targeting Iran’s nuclear ambitions with strikes on key sites: Natanz, Isfahan and Fordo using bunker buster bombs. While US officials claim victory, we await the full impact assessment. In our view, Iran’s potential closure of the Strait of Hormuz – pending approval from the National Security Council – is a last option due to its economic reliance on the passage and the risk of provoking a strong US military response. However, if Supreme Leader Ali Khamenei perceives no alternatives, he may resort to this extreme action. For an in-depth analysis, see Research Global – What if Iran closes the Strait of Hormuz?, 22 June.

This week’s macro data kicks off with a string of PMI releases: euro area manufacturing PMI has had a strong start of the year rising to 49.4 in May from 45.1 in December, while services has been on a declining trend, falling to 49.7 in May. We expect the manufacturing PMI to remain unchanged as the boost of front-loading of exports to the US has likely reversed while the ZEW rose in June in a more positive sign. We expect services to remain below 50 due to the weak consumer confidence that limits spending. We will also keep an eye on the US flash PMIs.

Key events for the rest of the week include the NATO summit and German IFO on Tuesday, with US PCE data set for release on Friday.

Economic and market news

What happened overnight

In the commodity space, Asian markets slipped as investors watched for Iran’s response to US strikes. Oil prices briefly hit five-month highs, settling with a 2.0% rise and trading at USD78.5/barrel this morning. The escalation of the Middle East crisis is expected to lead to the traditional safe heaven effects, with rising oil prices, lower equity pricing and a stronger dollar. However, the impact on US Treasuries remains uncertain due to trade deficits, tariffs, and potential increases in Treasury supply from soft fiscal policy.

What happened since Friday

During the weekend, NATO members agreed to increase their defence spending target to 5% of GDP ahead of the summit, as advocated by US President Trump. Spain, however, announced it would not meet this target, aiming for only 2.1% due to social spending concerns – a stance that may heighten tensions with Trump.

In the euro area, consumer confidence declined in June to -15.3 from -15.2, in contrast to expectations of a rise to -14.9. The weak consumer confidence is a drag on activity and dampens growth especially in the services sector. However, a strong labour market, rising real wages and lower rates are helping consumption, which is growing. But consumption growth had been higher if it was not for the weak confidence.

In Denmark, consumer confidence increased from -18.4 to -15.1 in June, reaching its highest level since February, yet still low. This rise is driven by improved perceptions of the Danish economy amid easing international tensions. Despite positive indicators like job growth, consumers remain cautious about personal finances due to inflation fears. Crucially, consumer spending has not sharply declined, supporting domestic growth. April’s payroll data revealed a strong increase of 5,400 employees, led by the private sector, despite ongoing tariff uncertainties.

Equities: Despite a barrage of geopolitical developments and a packed calendar of macroeconomic and monetary policy news last week, it is striking how little movement we saw across major asset classes. Yes, equities ended the week marginally lower overall, but the broad picture is one of stability. Cyclical sectors even slightly outperformed, volatility ticked up only marginally, and bond yields moved slightly lower – hardly the kind of response we would expect in such an environment. In the US on Friday, Dow +0.1%, S&P 500 -0.2%, Nasdaq -0.5% and Russell 2000 -0.2%.

FI and FX: Geopolitical tensions escalated over the weekend as the US conducted targeted strikes on three Iranian nuclear sites, which means that the US has now effectively joined Israel in its war in Iran. As a result, the oil price touched the USD80/bbl level as the market opened and traditional safe havens such as the USD and CHF have benefitted while US and European equity futures are trading lower. Key will be whether Iran resorts to closing the Strait of Hormuz from traffic, which would be a big shock the global economy and likely lead to a surge in energy prices and a sharp sell-off in risky assets.