Iran conflict: Asset-allocation and macro views

1. Macro: What the conflict means for global growth and interest rates – David Rees, Global Head of Economics, Schroders

We have been concerned about global inflation risk in the economy for some time, and have pushed back strongly against the slow-growth narrative, particularly in the US, because we felt that fundamentals were good. Our view is that the economy is vulnerable to price shocks that can become ingrained through labour markets, for example through wage bidding, and a stagflationary environment can emerge.

While a brief spike in oil prices would have little lasting effect on inflation (as energy prices would need to be sustained higher over weeks or months before we see it push CPI meaningfully higher), higher sustained energy inflation would squeeze real incomes, weigh on growth and raise doubts about whether central banks, such as the US Federal Reserve, can continue easing monetary policy.

If we do get an inflationary shock and headline inflation pushes up, it may give central banks pause for thought as it becomes difficult to justify rate cuts when inflation is starting to push higher, meaning rate cuts are less likely. To get rate hikes, we would need to see these pressures becoming ingrained in wages and second-round effects where inflation becomes embedded.

2. Commodities: Implications for oil and other commodities – Malcolm Melville, Fund Manager, Commodities, Schroders

Prior to the recent Iranian attacks, oil was cheap by historical standards at mid $60s per barrel (bbl). Inventories were high and oil market participants were not expecting events that would push oil prices higher. The consensus for the rest of this year was that oil prices would fall.

In the wake of the attacks, oil prices have risen. The Iranian response has been broader and more aggressive than in past incidents, such as last year’s 12-day war in June which saw prices spike to $78/bbl and then quickly reverse.

Strait of Hormuz critical for numerous commodities

A key difference now is that the Strait of Hormuz – one of the world’s most critical shipping chokepoints – appears virtually closed. There have been attacks on vessels in the area, as confirmed by UK Maritime Trade Operations. This creates a more complex and fragile dynamic than in previous short-lived episodes.

The strait is a narrow and highly exposed passage through which flows approximately:

• 20% of global oil supply
• 20% of global LNG
• Significant volumes of fertiliser (e.g. 33% of urea)
• 7% of global aluminium supply

A prolonged disruption would therefore affect multiple commodity markets, not just crude oil. A key question is how long the current conflict might last. President Trump has mentioned a four-week timeframe.

Sourcing alternative oil supply unfeasible

If the shipping via the Strait of Hormuz remains impaired for a long period, sourcing replacement oil supply will be extremely difficult. OPEC has announced a 200,000 b/d increase but this is immaterial relative to the scale of potential disruption.

Iran produces 3.4 million barrels per day (b/d) and exports 1.7 million b/d, largely to China – these are the flows that are most immediately at risk. China may seek to replace these with Russian oil, which is otherwise subject to sanctions. Another factor to watch is if India begins buying Russian oil again.

Disruption to shipping via the Strait of Hormuz would impact Saudi Arabia’s ability to export oil. Saudi Arabia exports 7–7.4 million b/d and could theoretically reroute volumes via its East–West pipeline. However, the pipeline has never operated at full capacity before and this would also require re-routing shipping, which would take time.

There is also the issue that Saudi exports are already close to their maximum levels. It seems unlikely that they have much flexibility to increase these, even if they are able to export via the pipeline rather than the Strait of Hormuz

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