Middle East tensions
Middle East tensions
Summary
After a period of relative resilience and calm, the current bout of military action between Israel and Iran has led to some market repricing, at least within the energy market. Whilst the oil price has increased by 23%, we have yet to see this spill over into asset classes. Oil prices have risen back to the levels seen at the start of the year so are yet to be economically impactful.
The key transport route for energy is the Strait of Hormuz, through which over 20% of oil and natural gas is shipped. If this is disrupted, then equity and bond markets may become more volatile. Natural gas prices have risen, and this may be a key factor as it was in 2022, post the Russian full-scale invasion of Ukraine, when European gas prices rose sharply, which contributed to weaker economic growth and inflation across Europe.
The US government budget negotiations are expected to draw to a close in coming weeks. The fiscal package is likely to result in elevated US government deficits. High fiscal deficits have been a feature of US economic growth over the past decade, in contrast with the fiscal responsibility and low economic growth of countries like Germany. With European countries changing in recent months to accept fiscal expansion (partly to fund higher defence spending) an open question is how these elevated fiscal demands will be financed, and will this cause bond yields to remain higher for longer?
Both the economic and profit outlook has stabilised in recent weeks. As the recessionary inducing tariff plans announced by President Trump in April have been watered down, so the forecasts for economic growth and profits have stabilised. Equities have climbed back to near all-time highs on the back of the resilience and potential recovery in profits. Non-US equities are seeing their profits rise more quickly than US companies, mainly due to the benefit of the lower US Dollar.
Whilst risk and uncertainty remain elevated, especially on the policy front as President Trump’s stance remains fluid on many issues, if the current conflict between Israel and Iran remains contained, then we expect rising profits and the prospect of interest rate cuts to feed through to continued resilience for investors.
Middle East risk rising
After the hubris and bluster of President Trump’s tariffs, investors had settled down to a period of relative stability. Equities had rallied back close to all-time highs as the US economy appeared to have weathered the turbulence for the time being.
The current Israel – Iran conflict has dampened risk appetite and may put a break on the economic recovery and market progress. The current escalation has resulted in a modest impact on global equity prices, with less than a 2% fall. Oil prices have risen from $60 at the start of June to $74 per barrel. The 23% price increase takes the price back to levels seen in February, so we would suggest that the global economic impact of the conflict is modest, currently. On the margin, the oil price increase is inflationary, but historically it takes a doubling of oil prices to result in a recession type impact on economic growth. It is worth noting that at 2.8 billion barrels, the scale of stockpiles are at a normal level, albeit towards the lower end of the range, but consistent with an $80 per barrel oil price, as shown in the chart.
The sharp oil price rise only brings oil prices back to the levels seen at the start of the year, and oil inventory remains within the ‘normal range’ seen over the past 15 years.
Source: Bloomberg, Artorius
As European gas storage is replenished in summer, the natural gas price (right hand side (RHS)) may be worth watching in the face of Middle East tensions and could be a potential inflationary impact for 2026
Source: Bloomberg, Artorius
It is not ‘just’ oil that matters. Natural gas may also be impacted. Natural gas came to the fore when Russia escalated their Ukraine invasion in 2022, having started their conflict in 2014 by annexing Crimea. The 2022 invasion resulted in a spike in natural gas prices, leading to widespread inflation across Europe. With storage levels low but being rebuilt, as is normal in the summer, a spike in natural gas prices may be felt keenly in winter and hopes of interest rate cuts in Europe and the UK may be delayed. Again, European economies are more exposed to the natural gas market volatility than the US economy due to the latter’s self-reliance in energy production.
Unlike equities, bonds have not responded positively (with bond yields falling) to the good news on the 12th of May of a tariff delay and the lowering of prospective tariffs. There may be other factors starting to filter into bond markets, which we will discuss below.
The US dollar, which has fallen since Trump has come to power, has stabilised, but remains lower than it was at the start of April when the tariff announcements started. Gold which has attracted investor flow through 2024, has fallen back 7% as the tariff tensions were eased, but remains 22% higher since the start of 2025.
If the current set of tariff plans are enacted, then the global economy will face a US tariff environment that is significantly worse than was the case prior to 2025. But for the time being, a period of stability and silence on tariffs appears to be welcomed by investors.
The largest risk would be if the Strait of Hormuz were to be closed to oil and natural gas shipping. About a quarter of the world’s oil trade passes through the Strait of Hormuz, which links the Persian Gulf to the Indian Ocean. In the past, Iran has targeted ships traversing the chokepoint and has threatened to block the waterway.
The strategic reason that this may not be what the Iranians want is that China, an ally of Iran, is a major recipient of the fuel that is shipped through the Strait. The US Energy Information Administration (EIA) estimates that 84% of the crude oil and condensate and 83% of the liquefied natural gas that moved through the Strait of Hormuz went to Asian markets in 2024. China, India, Japan, and South Korea were the top destinations for crude oil moving through the Strait of Hormuz to Asia, accounting for a combined 69% of all Hormuz crude oil and condensate flows in 2024. These markets would likely be most affected by supply disruptions at Hormuz, albeit other regions and economies would be impacted by any price shocks.
Destination of crude oil and condensate transported through the Strait of Hormuz: China (Iran’s key ally) is dependent on the energy shipped through the Strait so may apply pressure to keep shipping lanes open
US exceptionalism
Investors are waiting for the final negotiations around the US Budget. The 2024 budget deficit was a mind-blowing 6.4% of Gross Domestic Product (GDP); credible forecasts suggest that the deficit will exceed 7% of GDP for the rest of President Donald Trump’s term.
This assumes that there is no recession in the next few years as recessions typically see an increase in government deficits of around 4 percentage points as tax revenues fall and spending (unemployment benefits etc.) increase. Even without a recession, the plans would continue the extended period of high fiscal deficits run by the US.
Government deficits over the past 15 years: the US has persistently run the largest deficit
Countries with the largest fiscal deficits, Italy and the US, have enjoyed faster economic growth in recent years
We are struck by the degree to which those countries that have run high fiscal deficits have also generated faster economic growth in recent years. Maybe the outperformance of the US economy has been built on fiscal generosity as well as the energy self-reliance touched on in the paragraph above.
OECD forecasts for the structural deficit suggest that the deficits will shrink in the UK and US and expand in Japan and Germany over the next five years. If these forecasts translate into reality, then the extended period of US economic outperformance based on fiscal largesse may be reversed. However, the budget negotiations in the US are suggesting that fiscal largesse will continue in the US, which is likely to result in continued robust economic growth.
The questions may be, for how long will US fiscal deficits be funded? And what prospect is there for bond yields in a world of governments running prolonged deficits that require investors to buy government bonds at an increased rate?
A turn up in hope?
Economists, like weather forecasters, are expected to provide predictions. The chart below shows the prediction for economic growth in 2025 made by economists over the past two years. In the case of the US, forecasts for economic growth for 2025 were raised through the second half of 2024. Expectations for US economic growth in 2025 moved from a subdued pace of 1.5% to over 2% at the end of 2024.
Post the announcement of tariffs in early April, expectations for economic growth in 2025 were cut quite sharply. We note that the pace of cuts has stopped and there are some signs of a better outlook for US economic growth, even though these estimates are still lower than at any point over the past two years, likewise for other regions. Maybe prospects for the global economy have stopped getting worse, and that is good news given the worst-case scenario under Trump’s initial tariff plan in April.
Forecasts for economic growth in 2025 have started to stabilise, albeit from low levels, as President Trump’s tariffs are watered down
Source: Bloomberg, Artorius
Expectations for profits (measured by earning per share (EPS) have started to improve in recent weeks, after the downdraft caused by the tariff turbulence
Source: Bloomberg, Artorius
Similarly for profits, both for companies in the US and around the world, there had been a cut in the prospects for profits on the tariff news, but in recent weeks the cuts in profits expectations have been reversed and in the case for non-US equities, profits have started to be revised higher.
US equities have outperformed non-US equities for the past 15 years. Fundamentally the profits backdrop for US equities has been better than elsewhere. In 2025 this has shifted. Profit expectations for non-US equities have risen by more than for US companies, albeit some of this relative improvement reflects the fall in the US Dollar, which provides a boost to non-US profits.
However recent updates have seen non-US earnings start to outpace US earnings, in common currency terms. And this is showing up in the outperformance of non-US equities compared to US equities. If this continues then the long dominance of US equities versus all other equities may start to fade.
US equity performance versus the Rest of the World (RoW) appears to track relative earnings (EPS): with stronger US earnings driving higher relative performance versus non-US equities between 2023 and the end of 2024. This has reversed in 2025.
Source: Bloomberg, Artorius
Conclusion
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After a period of relative resilience and calm, the current bout of military action between Israel and Iran has led to some market repricing, at least within the energy market. Whilst the oil price has increased by 23%, we have yet to see this spill over into asset classes. Oil prices have risen back to the levels seen at the start of the year so are yet to be economically impactful.
The key transport route for energy is the Strait of Hormuz, through which over 20% of oil and Natural Gas is shipped. If this is disrupted, then equity and bond markets may become more volatile. Natural gas prices have risen, and this may be a key factor as it was in 2022, post the Russian full-scale invasion of Ukraine, when European gas prices rose sharply, which contributed to weaker economic growth and inflation across Europe.
The US government budget negotiations are expected to draw to a close in coming weeks. The fiscal package is likely to result in elevated US government deficits. High fiscal deficits have been a feature of US economic growth over the past decade, in contrast with the fiscal responsibility and low economic growth of countries like Germany. With European countries changing in recent months to accept fiscal expansion (partly to fund higher defence spending) an open question is how these elevated fiscal demands will be financed, and will this cause bond yields to remain higher for longer?
Both the economic and profit outlook has stabilised in recent weeks. As the recessionary inducing tariff plans announced by President Trump in April have been watered down, so the forecasts for economic growth and profits have stabilised. Equities have climbed back to near all-time highs on the back of the resilience and potential recovery in profits. Non-US equities are seeing their profits rise more quickly than US companies, mainly due to the benefit of the lower US Dollar.
Whilst risk and uncertainty remain elevated, especially on the policy front as President Trump’s stance remains fluid on many issues, if the current conflict between Israel and Iran remains contained, then we expect rising profits and the prospect of interest rate cuts to feed through to continued resilience for investors.
Important Information
Artorius provides this document in good faith and for information purposes only. All expressions of opinion reflect the judgment of Artorius at 20th June 2025 and are subject to change, without notice. Information has been obtained from sources considered reliable, but we do not guarantee that the foregoing report is accurate or complete; we do not accept any liability for any errors or omissions, nor for any actions taken based on its content.
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