Our base case view is that the US/Israel attacks on Iran and related broader Middle East disruption will be relatively short-lived and energy prices should revert back to near pre-attack levels, with limited negative impact on the medium-term macro outlook. However, in such a volatile and unpredictable environment, the US’s ability to control outcomes and the risk of unintended consequences remains high, with the US and its potential partners’ ability to restore shipping flows through the Strait of Hormuz particularly critical. A scenario of sustained shipping and/or regional production disruption would keep oil and natural gas prices higher for longer, with negative implications for global growth and inflation. However, even in such a scenario, we think the risk of global recession remains low.
Why we believe the most likely scenario is the US/Israel attacks on Iran and related broader Middle East disruption will be relatively short-lived and therefore should not have a large sustained negative impact on energy prices and the macro outlook:
- The US’s stated aim in the attacks on Iran is to destroy Iran’s ballistic missile capabilities and its nuclear programme. It has said that regime change is not the primary goal. Most analysts believe it is highly unlikely the US will put troops on the ground. This should limit the timeframe of the attacks, with most analysts and Trump’s initial statements indicating the strikes will take place over weeks rather than months.
- OPEC spare capacity is sufficient to compensate for a full loss of Iran’s oil supply (see chart below).
- Most analyses indicate the US military has the resources, capability and will (once the initial attacks on Iran are complete) to prevent an extended closure of the Straits of Hormuz. This should limit the risk of a sustained period of elevated energy prices.
- Trump is laser-focused on not losing the Republican’s congressional majority in the November mid-terms as it would hobble the last two years of his presidency. He therefore will not want to see a sustained rise in oil and gasoline prices that will hurt his popularity with the electorate. Related to this, most polls indicate the majority of Americans are against the attacks.
- A prolonged conflict and sustained high energy prices would push inflation higher making it difficult for the Fed to cut interest rates and would likely keep government bond yields high. This also goes against Trump’s key stated goals of bringing down the cost of living and lowering interest rates.
- A sustained rise in energy prices (ie, months rather than weeks) would hurt US and global growth and push unemployment higher. There are a range of estimates on growth and inflation sensitivity to higher oil prices, but a Fed study based on the oil price shock caused by Russia’s invasion of Ukraine, found around a 0.13% decline in GDP growth and 0.15% increase in headline inflation for every sustained 10% increase in the real oil price. Europe growth (though not inflation) tends to be slightly more sensitive to energy price hikes (with the exception of Norway which is a net oil exporter). However, on this basis it would take a very substantial and prolonged increase in energy prices to materially change the growth outlook. Trump has made it clear he is aware of this risk, and it is likely he will want to avoid it in the run-up to midterms.
- Therefore, it would appear the Trump administration is planning relatively short-lived and intense attacks to substantially reduce Iran’s military capabilities and its current senior leadership but is unlikely to have the appetite to extend this into a protracted war that keeps energy prices high and risks further antagonising the electorate.
Of course, in such a volatile situation, the risk of unintended consequences remains high, and it is possible that the Iran’s outward attacks create a more disruptive and long-term conflict. While not our base case, this is a risk that needs to be monitored.
Go deeper
- Brooks assesses the outlook for the year ahead
- ICG’s Chief Economist speaks with Bloomberg about AI‑driven uncertainty fuelling volatility
- Explore our investment strategies in the ICG Client Lounge
- Follow ICG on LinkedIn
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