Why markets might be having a change of heart about the Iran war
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The war in Iran started over the weekend, but it wasn't until Tuesday that the markets began to register the disruptions ahead.
Oil (BZ=F) and gas prices rose, stocks fell multiple percentage points, and Treasury yields climbed as traders contemplated the inflationary impact of an escalating war in Iran.
Read more: What an extended war with Iran could mean for gas prices
I'd mention bitcoin, but boy, the crypto-heads have been real quiet during this period of global instability.
If it was contrarian and a little clever earlier this week to downplay the potential impacts of an American military campaign against Iran, that dynamic has now flipped, and is starting to flop again.
The president and top US officials have indicated the military is preparing for a widening conflict that might last weeks. And market consensus is rapidly catching up. Shrugging off geopolitical uncertainty, as Wall Street had done with conflicts past, isn't the right model anymore, the markets are suggesting. The goal now is to reprice the Iran risk, with a much heavier hand.
That was the calculus until Tuesday afternoon, when the S&P 500 (^GSPC) had shed around 2.4%. After that reflexive tightening, the rest of the afternoon, just like the day before, saw losses pared back. The S&P 500 only closed 0.9% down.
While the level of severity continues to be repriced on an hourly basis, the verdict is coming in: This is not something to be waved away. And for good reason.
The ever-present risk of a system-wide energy shock
“The confrontation is unfolding adjacent to the world’s most strategically important energy corridor: the Strait of Hormuz," said EY-Parthenon chief economist Gregory Daco in a note on Tuesday. "Any threat to vessel safety in the Strait of Hormuz immediately raises the risk of a system-wide energy shock.”
The negative turn in markets is reflected in and amplified by increasingly dire coverage of the military actions in the Middle East and the widening scope of the conflict. Highlighting Iran's capacity to retaliate against neighboring states over a wide geography, the State Department has urged Americans to leave 14 countries in the region.
Disruption multiplied by time
The impact of a system-wide shock can be represented by a simple equation: shock x time.
How severe is the shock, and for how long, remains fraught, with differing expectations over the potential duration of the war in Iran.
