Oil prices fall when supply is abundant and/or demand is scarce. Equities strengthen when economic prospects are sanguine. In light of this economic trivia, it is worth re-citing the US Treasury Secretary. As the US imposed fresh sanctions on Iran on Monday, it targeted digital assets, technology, gold, aviation and shipping—with emphasis on the last one. The cantankerous announcement also carried a warning that a ‘defined timeline’ would be given to Iran’s trading partners to sever ties or risk being ‘cut off from the US financial system’. Yet oil dropped like a stone over two days, stocks strengthened yesterday, and bond yields stabilised.

What on earth is happening? The threat of secondary sanctions, coupled with the renewed US-Canada trade war, should send shivers down the spines of stock and bond investors. But they did not. A plausible explanation is that the threats were simply ignored and the administration’s narrative has lost credibility. Tweaking the Chinese lion’s tail proved dangerous in the past and would be risky in the future.

The volume of oil Iran has managed to smuggle into the market should fall. So why has Brent dropped more than $6/bbl in just two days and another $2/bbl this morning? Is it the alleged interim agreement between Oman and Iran to demine and manage traffic through the Strait? The market seemingly believes so, but the permanent resumption of the flow of 20 mbpd of oil is anything but a foregone conclusion. All the while, an oil tanker was struck near Oman, and transit via the chokepoint is at a three-month low. It is challenging to reconcile why economic pressure, instead of military action, would increase the availability of oil through the Strait of Hormuz, which is closely guarded by Iran. The view from this chair is that supply risk will persist and oil inventories will continue to deplete in the coming weeks and months, especially those of products. But sitting in this chair has often proven uncomfortable recently.

Immediate and Far-reaching Reverberations

The nature, cause, necessity and justification of the Iranian war will be debated for years to come. What is currently visible is deeply troubling. A perpetual conflict is being fought in the Middle East, now in its sixth month, significantly longer than the promised four to five weeks. There is no clear pathway to ending it; consequently, oil prices remain volatile at best and unpredictable at worst. A valiant effort to bring the price of crude oil down from above $120/bbl has been successful. Still, the discernible shortage of refined products, mirrored in the $100/bbl premium commanded by diesel over WTI, is more than concerning. Regional powers are adversely affected, with Qatar, for example, forced to cut government spending. Broader political and economic implications are difficult to foresee, but they look equally ominous.

The US economy: The President’s election victory in 2024 rested on the tenets of ‘no more forever wars’ and bringing down consumer prices. Yet there have been constant threats to seize Greenland, the former Venezuelan president was captured in Hollywood-style fashion, and the Middle East conflict shows no signs of abating. The results are painfully plain to see for the US electorate: galloping gasoline and diesel pump prices, mortgage rates testing 7%, bond yields at multidecade highs, inflation far from the 2% objective, and government debt exceeding $40 trillion. The President’s approval rating, particularly regarding his handling of the economy, is at historic lows as voter discontent continues to grow.

Geopolitical hotspots: The Middle East conflict directly or indirectly has a profound impact on the war in Ukraine and on China’s long-term ambitions regarding the annexation of Taiwan. Ukrainian resistance, based on effective drone warfare, has given the occupied nation the upper hand in recent months, so much so that, during the latest NATO summit in Ankara, Donald Trump was contemplating granting Ukraine a licence to produce critical Patriot interceptor missiles, only to backtrack on the promise three weeks later. This is evidence of the Administration’s capricious foreign policy and has reportedly been the result of warnings to shelve plans to escalate the conflict with Iran and further drain US missile stockpiles. Right on cue, Russian ballistic missile attacks on Ukrainian industrial and civilian targets have intensified, handing the initiative back to the aggressor.

We have recently touched upon reports about the state of the USS Abraham Lincoln and the morale on board. Conditions were allegedly substandard, and while CENTCOM commanders would refute the accusations, the USS George Washington aircraft carrier from the Pacific region has been sent to the Gulf to relieve the troubled ship. It will not trigger the immediate military invasion of Taiwan, but China will feel emboldened to increase political and military pressure on the island in pursuit of its ultimate goal.

Middle East military alliance: The Iranian crisis has likely changed the security status quo in the Middle East, as the US is no longer viewed as a strategic and trustworthy ally. This became abundantly clear after August 7, when Saudi Arabia, Turkey and Pakistan signed the Makkah Joint Defence Agreement, a military alliance with a provision analogous to Article 5 of NATO, whereby an attack on one member is deemed an attack on all members. The agreement is defensive in nature, and it does not target Iran in particular; however, it is clear that the Persian Gulf crisis and the need to ensure regional security, including safe shipping through the Strait outside the US security umbrella, were motivating factors in forming the new alliance.

Trade wars: US trade wars, which started well before the Persian Gulf crisis, have no palpable relationship to the Iranian crisis, yet the recent breakdown of tariff talks between Canada and the US might be more than just coincidental. It can be viewed as a bold, or even brazen, move by Canada, one of the US’s most important trading partners, just ahead of the midterm elections. This will do nothing to ease inflationary pressure or, therefore, economic grievances before November. Others in the US crosshairs are watching developments with their eyes peeled, and further friction cannot be ruled out over the next two months.

Iran is a danger to political stability in the region. Nevertheless, the increasingly ubiquitous view is that dealing militarily with its nuclear capability has been an unmitigated disaster. In the process, the US has lost a huge amount of credibility, trust and foreign-policy capital. The above list would seem to support that view. Regaining that trust will take longer than the time the incumbent administration has to make amends, even if it were willing to do so. But it is not. Brace yourself for prolonged turbulence.

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