On Saturday 28th February, the US and Israel launched an attack on Iran, in which Iran’s supreme leader was killed. Iran has responded with retaliatory attacks on Israel, and by striking neighbouring Arab states that host US bases, as well as a British military base in Cyprus. Iran has also attacked ships in the Gulf, prompting the closure of the Strait of Hormoz. This has driven commodity prices higher, while broader market conditions have remained volatile.
Iran’s response to the US and Israeli attacks has been broader than in previous instances, such as the 12-day war in June last year. Key energy infrastructure is being targeted by Iran, most notably the Strait of Hormoz. This is a crucial shipping channel responsible for around 20% of global oil and gas supplies, as well as other commodities such as fertiliser and aluminium.
Oil prices have risen around 14% since Friday, at the time of writing. Global equity markets fell roughly 1.6% across Monday and Tuesday but have stabilised somewhat on Wednesday. However, equity markets in countries that rely on Middle Eastern oil imports, notably South Korea and Japan, have fallen further. Global government bond yields have generally edged higher, as concerns around high energy prices have pushed up interest rate expectations, given the potential impact on inflation.
If the sharp rise in commodity prices proves short lived, the impact on inflation should be limited, and central banks are likely to look through a temporary spike. However, if there is a longer-term conflict, with the Strait of Hormoz closed for an extended period, energy prices could remain elevated. This could lead to an increase in inflation expectations and weigh on global growth, posing a greater challenge for central banks and potentially delaying interest rate cuts.
Spence View
We believe that amid uncertain geopolitical conditions, pension schemes should remain well diversified to navigate the broader market volatility. We believe that it is too early to determine whether this will be a short-term conflict or potentially develop into a longer-term conflict, so our clients should not panic, and avoid making immediate strategic asset allocation changes. Instead, we believe the shorter-term tactical calls should be left to the underlying active fund managers.
There is limited direct exposure to energy within global equity markets, with the sector representing around 3% of the global index, although it accounts for closer to 10% in UK equities. We believe the main risks are more the second-order effects of sustained high energy prices on inflation and economic growth.
We will continue to monitor the situation, and please do let us know if you have any questions in the meantime.
