Over the weekend the US entered the military conflict between Israel and Iran by bombing the latter’s nuclear installations. This represents a wider escalation of the military conflict than was expected at the end of last week and has led to speculation that we could be on the precipice of a wider regional conflict.
The baseline scenario is still that the US wants to neutralise Iran’s nuclear installations and force it to the negotiating table. The key objectives the US will have involve agreement from Iran on a verifiable path to denuclearisation, the curtailing of its ballistic missile programme and ending its support for regional proxies in Iraq, Syria, Lebanon, Yemen and Gaza.
In this scenario Israel and the US would, on balance, be content for the current Iranian regime to remain in place in its current weakened form. This is certainly consistent with the weekend commentary from several US officials who indicated that the US air strikes would be a one-off exercise. However, President Trump has muddied this narrative by posting on Sunday night that Iranian regime change could be a desirable objective to pursue.
In terms of broader geopolitics, the weekend US military action has elicited a predictably negative response from Russia, with whom Iran has been forging a deepening strategic partnership, and China, which is Iran’s largest trading partner. In addition to Trump’s well-known reluctance to mobilise the US military in drawn out foreign conflicts, this broader context is likely to constrain the extent of further US involvement in the current conflict.
A key focus is the Strait of Hormuz, through which roughly 30% of the world’s seaborne oil trade passes – as it is the only sea passage from the Persian Gulf to the open ocean. It is a narrow Strait, just 21 miles wide at its narrowest choke point, and is bordered by Iran in the north and Oman in the south.
There are reports that over the weekend the Iranian Parliament passed a measure to close the Strait, but at the time of writing the decision had yet to be ratified by Iran’s Supreme Council. The Strait of Hormuz has never been successfully blocked, but were this to occur the impact on the oil price would be exponential, with estimates of $130+ per barrel. A sustained move to this level would push up inflation around the globe to 5% and add significantly to the pre-existing headwinds to growth from US trade policy.
The above scenario is very much a ‘worst case’ outcome, and we feel that it is a low probability event given that Iran would be damaging its own position, both economically and politically, by acting against the interests of China, its main customer. More broadly, the key regional players would want a strictly contained conflict, given that the economic transformation they have embarked upon will be jeopardised by a sustained regional conflict. Finally, and given Trump’s stated commitment to keeping energy prices low, even a short-term hike in the oil price to anywhere near this level would be viewed as a major policy misstep from his administration. All this suggests that the most likely scenario is one of limited containment, where the conflict could remain largely bilateral between Israel and Iran, with the US avoiding deeper involvement unless directly attacked.
The financial market response has thus far been measured, with the oil price rallying to levels last seen at the start of the year, equities retracing from recent highs and inflation expectations in the bond market edging higher. Whilst adverse geopolitical developments can affect investor sentiment in the short term, it is nonetheless important to have a fundamental framework to assess whether it is safe to be fully invested over a medium to long-term time horizon. The key drivers of equity returns are economic growth, inflation, fiscal policy, central bank policy rates, the liquidity cycle and corporate earnings delivery. Our assessment of these in the round is that they are likely to be a positive backdrop to equity markets heading into 2026 and beyond, with Trump keen to engineer a significant equity market rally ahead of the Autumn 2026 US Midterm Elections.
The value of securities and the income from them can fall as well as rise. Past performance should not be seen as an indicator of future returns. All views expressed are those of the author and should not be considered a recommendation or solicitation to buy or sell any products or securities.
