Iran and the Middle East: Escalation, Uncertainty and Investment Implications (update)

The conflict involving Iran, Israel and the United States has entered a more acute and uncertain phase, with markets now focused on a near‑term escalation risk tied to the status of the Strait of Hormuz.

While the situation has already resulted in a material energy supply shock, recent developments underscore the potential for rapid further deterioration, depending on whether shipping through the Strait resumes or hostilities intensify further.

What has happened?

Since late February, direct military confrontation between Iran, Israel and the United States has broadened in both scale and scope. Coordinated US–Israeli strikes on Iranian military, nuclear and energy infrastructure have been followed by sustained Iranian retaliation via missile and drone attacks across Israel and the Gulf, including against regional energy facilities and shipping assets.

Most significantly, Iran has effectively restricted commercial transit through the Strait of Hormuz, a critical chokepoint through which around 20% of global oil and liquefied natural gas (LNG) supply normally flows. While limited shipping has continued under constrained conditions, tanker movements have fallen sharply, resulting in stranded supply, rising insurance costs and severe logistical bottlenecks.

A temporary ceasefire was agreed earlier this month but has since proven fragile, with renewed tensions and disruptions highlighting the difficulty of achieving a durable de‑escalation. The conflict has therefore shifted from a short‑term geopolitical shock toward sustained supply‑side disruption, with markets increasingly sensitive to the risk of further escalation.

Market reaction so far

Oil prices have risen sharply and remain highly volatile. Brent crude peaked above $110 per barrel, compared with around $70 prior to the conflict, while US WTI crude has at times traded at a above $115. Gas and refined fuel prices have also increased materially. Crucially, current pricing reflects not only barrels already lost, but a significant escalation risk premium, with markets assigning a non‑trivial probability to further disruption of Middle Eastern energy flows. Even in a de‑escalation scenario, damage to infrastructure and shipping capacity suggests that supply constraints may persist for months rather than weeks.

Equity markets have been volatile. Energy, defence and some commodity‑linked sectors have outperformed, while energy‑intensive industries and consumer‑sensitive sectors have come under pressure. Bond markets reflect competing forces with demand for safe‑haven assets being offset by concerns over persistent inflation and fiscal pressures. Credit spreads have widened modestly, particularly in higher‑yielding areas of the market.

A key risk in the current environment is the potential for a renewed and persistent inflation shock. Iran had continued to restrict shipping through the Strait of Hormuz, and following no deal being reached in talks this weekend, the US administration has signalled it will apply an ‘everyone in and out’ or ‘no-one in an out’ approach to the Strait.  The US will therefore enact a total blockade of the Strait, which will further disrupt the global energy supply, reinforcing upward pressure on oil, gas and refined fuel prices.  The US is one of the countries least impacted by the closure of the Strait, and the blockade is a clear tactic to bring additional pressure onto the Iranian leadership as the rest of the world grows increasingly nervous at vital energy supplies being choked off, whilst depriving Iran of its main source of revenue – oil exports.    

One of the first second‑order effects of this ‘energy crisis’ has already been a repricing of expected central bank policy, with markets pushing back anticipated interest‑rate cuts and signalling that rates may remain higher for longer. We can see this at play in the residential mortgage market. That said, rate expectations have been moving rapidly as investors and analysts seek to interpret a fast evolving situation. Beyond monetary policy, sustained energy driven inflation would increasingly feed through to electricity prices, transport costs and wider supply chains, eroding real household incomes, compressing corporate margins and constraining policymakers’ ability to support growth. The resulting combination of elevated inflation, tighter financial conditions and softer demand would create a more challenging macroeconomic backdrop, increase market volatility and raise the risk of a stagflationary environment.  

One UK based think tank has already predicted the average UK household will be £480 worse off this year – a result of higher prices at the pump, and a material energy bill increase expected to hit when the UK energy price cap is revised in June.  This is against a backdrop of the UK balance sheet already being stretched, with taxes and government borrowing both at record levels.  This means there is little room for policymakers to provide a cushion to the UK economy – which is one reason why the discussions around increasing the extraction of domestic oil and gas supplies have come to the forefront in recent weeks.     

Investment considerations

For long term investors, the immediate market moves are less important than the potential follow-on effects:

• Inflation and interest rates: Higher oil prices feed directly into energy costs and more broadly into headline inflation, which may push-back expected interest rate cuts from the Bank of England and the Federal Reserve – although, due to its domestic energy production, the US is more insulated than many other countries against supply shocks to the Middle East.
• Inflation protection: In an environment where inflation shocks risk becoming more persistent, assets with explicit or implicit inflation linkage can play an important role in helping preserve real returns.
• Portfolio resilience: Periods of geopolitical stress reinforce the importance of diversification across asset classes, regions and risk drivers.
• Cashflow: The shock to asset prices may result in a crystallisation of losses if risk assets are required to be sold for cashflow purposes. Revisiting designated cashflow strategies can be beneficial under such circumstances. 
• Avoiding short termism: Geopolitical shocks are inherently difficult to predict and often fade from markets faster than headlines suggest. Wholesale portfolio changes based on near term events risk crystallising losses.

Conclusion

The current phase of the conflict represents a period of heightened asymmetry. While de‑escalation would likely ease market pressures relatively quickly, further escalation could have outsized consequences for energy markets, inflation and growth.

To help pension schemes, charities and endowments navigate this environment, the focus should remain on understanding vulnerabilities, stress testing portfolios against adverse scenarios and maintaining disciplined, long term investment strategies.

We continue to monitor developments closely and will provide further updates as the situation evolves.

Disclaimer:

Quantum Advisory is the trading name of Quantum Actuarial LLP which is authorised and regulated by the Financial Conduct Authority. 
Information and opinions quoted in this presentation cannot be seen as complete and should not be acted upon without formal advice.
Please note that the price, value and income derived from investments may fluctuate in that values may fall as well as rise and an investor may get back less than originally invested.