Global markets price stagflation risk from a protracted war

Five days of continuous Israeli and US bombing of Iran, the killing of Ayatollah Khamenei and at least five dozen other senior military and political leaders of the Islamic Republic, the de facto closure of tanker traffic in the Strait of Hormuz, the shutdown of Saudi Arabia’s Ras Tanura refinery and the world’s biggest LNG complex in Qatar, as well as retaliatory drone and missile attacks by Iran on airports, seaports, hotels, military bases and embassies in all six GCC states.

These are unmistakable metrics of regional escalation with no immediate prospect for a ceasefire, let alone a viable diplomatic solution.

After a muted response in the first trading session since the start of Operation Epic Fury, global financial markets are now pricing in the seismic macroeconomic fallout of a full-scale, high-tech war that has not spared the Gulf’s energy infrastructure and maritime chokepoints, restricting the passage of almost 20 percent of the world’s oil and LNG supplies from the strait to the Arabian Sea.

The global economy now faces the simultaneous shock of a hit to industrial growth and higher inflation.

The nightmare stagflation scenario was instantly reflected in global commodities markets.

Brent crude has surged from $60 per barrel just before US President Donald Trump’s use of military force to capture and extradite Venezuelan leader Nicolas Maduro on January 3 to above $82 now, a 28 percent geopolitical risk premium that shows no signs of short-term compression.

Natural gas prices in Europe have risen by a catastrophic 65 percent and saddled the continent with its worst energy crisis since the Kremlin’s invasion of Ukraine and sanctions on Russian gas imports in 2022.

War-risk insurance premia have skyrocketed from 0.2 percent to 1 percent in Lloyds of London, while oil and LNG tanker freight rates have tripled since Epic Fury began five days ago.

No wonder industrial metal prices on the LME are down 4-5 percent, led by Dr Copper and nickel, even though crude, natural gas, heating oil, jet fuel and diesel prices exhibit all the signs of a supply shock.

The impact of a full-scale Middle East war on the $9 trillion-a-day global foreign-exchange market has been traumatic.

The US dollar and the Swiss franc have emerged as the classic safe-haven beneficiaries while the euro has fallen from 1.18 before the war to 1.16 now. Sterling is trading at a mere 1.3280 against the US dollar even as traders price out the prospect of any imminent Bank of England base rate cut this spring.

The EU and Britain are far more vulnerable to a cut-off of oil and LNG imports from the GCC than a US economy insulated by its vast shale oil resource endowment.

Risk-sensitive currencies such as the Australian dollar, the South African rand and the Indonesian rupiah have swooned in unison against a resurgent King Dollar as the war escalated in the past two days, with the most damage felt in the stock markets of energy importers such as Japan, South Korea, Taiwan and even China.

The KOSPI in Seoul, the best-performing major stock index in the world with a 150 percent rise since January 2025, is now limit-down with a 5 percent daily loss on Tuesday, March 3.

The winds of war have cast a big chill on the energy-intensive industrial constellations of the Pacific Rim, the planet’s preeminent economic centre of gravity.

The US dollar index has risen almost 2 percent to just below 100 on safe-haven flows into the greenback as fighting rages in the skies above Iran and the Gulf’s energy complex virtually shuts down.

This is the doomsday scenario for the energy-importing emerging markets of Asia, led by China and India.

China depends on the GCC, Iran and Iraq for 45 percent of its energy imports. While the PRC is the sole buyer for 90 percent of Iran’s sanctioned oil exports at cut-rate prices, loadings from Kharg Island constituted only 12 percent of Chinese oil imports.

The loss of Venezuelan and Iranian cut-rate crude is a macroeconomic headwind for China but the Politburo’s decision to replenish its strategic petroleum reserves to 110 days of demand will protect the Dragon Empire from a short-term energy crisis. However, it is doubtful whether Beijing will achieve President Xi Jinping’s 5 percent GDP growth target for 2026.

Inflation risk rightly obsesses the world’s bond markets since a protracted war in the Gulf, a global energy shock, a decline in Europe and the Pacific Rim, industrial production and deglobalisation are all inconsistent with a goldilocks scenario, let alone any Panglossian hopes for price stability.

No wonder the yield on the 10-year US treasury note, the planet’s cost of long-term capital, has risen from 3.94 percent to 4.10 percent in the first days of Operation Epic Fury.

A US stock market trading at a valuation multiple of 22 times earnings and consumed by worries about AI disruption, Trump’s new tariffs and Wall Street’s private-credit cockroaches, must now contend with a rise in inflation amid the exogenous shock of yet another war in the Gulf.

Prospects for a Federal Reserve rate cut at the March or even June FOMC meetings amid such geopolitical and energy market turmoil are utterly unrealistic.

Risk assets, led by high-beta technology stocks and speculative assets like crypto and silver are vulnerable to steep sell-offs as plunges in bitcoin, which has recovered a little following a 5 percent drop, ether and silver futures attest.

Even the yellow metal has lost its lustre as a safe haven above $5,300 an ounce as global markets exhibit a new spasm of risk aversion.

In this uncertain milieu, cash is king but it is prudent to be careful about the currency and bank in which you choose to squirrel your money.