Weekly Update - War in the Middle East: the conflict is becoming deadlocked and energy risks are mounting

The conflict between the United States, Israel and Iran is entering its third week, with no tangible sign of a deescalation. The deadlock in the conflict is already having visible economic and financial consequences, notably through the closure of the Strait of Hormuz since 28 February, which is keeping oil prices high. The main risk lies in a prolongation of this closure, which could have a more lasting impact on energy markets and, by extension, on production in the most fuel-intensive sectors. Against this backdrop, equity markets remain down, whilst bond markets are now pricing in the prospect of tighter monetary policies. In light of this deteriorating environment, we have decided to adjust our portfolios to bring them closer to a Balanced allocation.

Energy markets have been severely disrupted. The main trigger is the closure of the Strait of Hormuz, which occurred right at the start of the conflict – a situation without historical precedent. As a result, nearly 20% of global oil and gas production and transit remains blocked, keeping oil prices high, at around USD 100 per barrel. Beyond the oil market alone, tensions are spreading to other energy-intensive sectors, such as aluminium, or those dependent on petrochemical inputs, such as fertilisers, where prices are also rising significantly. The duration of the strait’s closure is a key risk factor, with repercussions across the entire petrochemical production chain. According to the International Energy Agency (IEA), a one-month closure of the Strait of Hormuz would result in a normalization period of between three and six months for oil, gas and derivatives production chains. Against this backdrop, energy prices could remain under pressure in the coming weeks.

Rising inflation expectations and increased vigilance on the part of central banks. The sharp rise in energy prices and the increased likelihood that they will remain at these levels have led to a significant rise in inflation expectations. Consequently, the German 10-year inflation-linked bond now reflects expectations of around 2.2%, compared with 1.8% before the crisis began. Against this backdrop, monetary policy expectations have shifted markedly. In the United States, markets now expect the Federal Reserve to maintain the status quo, whereas two rate cuts had previously been anticipated. In Europe, investors are now pricing in at least one ECB rate hike, compared with the stability previously anticipated, as the impact of the energy crisis is deemed to be more pronounced on the continent. These developments reflect central banks’ desire to keep inflation expectations anchored, in an environment where successive supply shocks since 2020 have kept inflation above target levels. These revisions to interest rate paths are reinforcing the downward trend in equity markets, with the majority of indices posting negative returns since the start of the year.

We are reducing our overweight position in European equities, to bring it back to neutral, thereby taking profits after maintaining an overweight position for over a year. Whilst our macroeconomic outlook remains broadly positive — underpinned by expansionary fiscal policies and the resilience of household and corporate balance sheets — and whilst we continue to expect the ECB’s key interest rates to remain stable in the medium term, the energy crisis and tightening financial conditions now represent significant headwinds for European equities.

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