Middle East Hostilities Escalate, Investors Brace for 'Long Grind'
Quick Look
As Middle East hostilities escalate following US strikes on Iranian targets and retaliation, investors are pricing in a prolonged conflict, a 'long grind,' and higher risk premiums for geopolitical uncertainty.
AI-generated summary
Why It Matters
Hostilities in the Middle East have flared up again following US strikes on Iranian military targets and subsequent retaliation from Tehran against Gulf countries. This has led to disruptions in shipping through the Strait of Hormuz.
As hostilities in the Middle East flare up again, investors are increasingly grappling with the possibility of a prolonged conflict and pricing in a "long grind."
The latest escalation comes after U.S. Central Command struck Iranian military targets, drawing retaliation from Tehran, which attacked Gulf countries on Thursday.
U.S. futures were up, though markets in Asia were broadly lower. Oil, which was last up about 2% Thursday, has stayed below $100 a barrel as traders still see enough buffers in the market to prevent a full-blown supply shock.
Despite disruptions to shipping through the Strait of Hormuz, alternative export routes, increased U.S. energy exports and strategic petroleum reserve releases have helped cushion the blow.
For investors, the bigger challenge may be a world in which energy costs remain elevated, while borrowing costs stay high. The Iran conflict, which the U.S. said will not be an "endless" one, looks like getting increasingly protracted, if not turning into a "forever war."
"The forever war label puts the emphasis in the wrong place. Wars rarely run forever, but risk premiums can," said Billy Leung, investment strategist at Global X ETFs.
"With mediation collapsing and strikes resuming, markets have moved from pricing a ceasefire to pricing a long grind," he said.
As each new exchange of strikes makes a diplomatic resolution look less likely, markets are bracing for a longer conflict. The result may not be a sharp downturn, but it could be something more lasting: a world in which investors demand a higher premium for geopolitical risk, even after the headlines fade.
Leung said that investors are no longer treating the conflict as a temporary inflation shock. Instead, markets are repricing the cost of capital in a world of elevated geopolitical uncertainty.
"A prolonged war ends the era of buying everything and being rewarded," he said. "With energy costs and the real cost of capital both rising, earnings hurdles move higher across the board."
What to Watch
AI outlook — possibilities, not facts
Markets will continue to price in a higher premium for geopolitical risk.
Very likely · Medium term
The conflict will not be an 'endless' one, but may become protracted.
Likely · Medium term
Earnings hurdles will move higher across the board.
Very likely · Medium term
Open Questions
- What is the duration and ultimate scope of the current hostilities?
- Will mediation efforts be revived, and what are the prospects for a diplomatic resolution?
- What will be the long-term impact on global energy supply and prices?
- How will sustained high borrowing costs and geopolitical uncertainty affect corporate earnings and market valuations?
