Oil price surge prompts risk-off sentiment

Podcast:Across the Pond: Strait Talk – Trump, Iran, and the global ripples CIO geopolitical experts Dirk Effenberger and Kurt Keiman break down the global implications of the Iran conflict and the impact of the broader shift in US foreign policy on markets AppleSpotify (23 mins)
Podcast: Jumpstart: What will investors be looking for in the week ahead as the Iran conflict evolves? (6 mins)
Podcast:Signal over Noise with Ulrike Hoffmann-Burchardi AppleSportify
Video: Investors Club | Oil prices, defense stocks, and Fed policies (8 mins)
Video: CIO’s Min Lan Tan on what AI and geopolitical shocks means for APAC and EM equities (7 mins)

What happened?
Crude oil prices surged to their highest level since 2022 and global equities fell on Monday morning on escalating hostilities in the Middle East over the weekend. The Strait of Hormuz remains de-facto closed, triggering oil production shut-ins, and the nomination of the late Ayatollah Ali Khamenei’s son, Mojtaba, as Iran’s new supreme leader suggests hostilities between the US, Israel, and Iran could last for longer.

Brent crude oil spiked as much as 29% on Monday, testing USD 120 a barrel in the Asia session, before moderating to around USD 103/bbl at the time of writing. The Nikkei 225 and KOSPI fell 5.2% and 6%, respectively. The Stoxx Europe 600 was down by 1.5% at the time of writing, and S&P 500 futures are pointing 1% lower ahead of the US market open. With the market considering the risk of potential changes in interest rate policy, the US dollar strengthened further, government bonds sold off, and gold fell by around 1.5%.

Over the weekend, the UAE, Kuwait, and Iraq cut oil output as their limited storage capacities forced them to shut in production after available tankers were fully loaded. Outside the Gulf, oil on water (tankers) is being drawn down due to the limited amount of oil transiting from the region.

Meanwhile, various media outlets have reported that US President Donald Trump is weighing using special forces on the ground to seize Tehran’s uranium, Iran has continued attacks on neighboring states, including on civilian infrastructure, and Israel struck fuel depots in Tehran and threatened the Islamic Republic’s power grid.

What do we think?
With the conflict entering its tenth day, we make three observations:

1. The oil market will continue to tighten until the Strait is re-opened or demand is cut. Currently, only two to three tankers are crossing the Strait each day, compared with the typical level of 30-35. As long as supply is constrained, oil prices will rise further until demand falls. Global markets are therefore likely to progressively price a more negative economic outcome as more time passes.
2. A resolution may take longer than markets like. An absence of clear regime change may lead the US and/or Israel to persist with military action for longer. Meanwhile, rising energy prices also provide Iran with leverage, and fully eliminating the Iranian threat to shipping is likely to prove very challenging. Even if President Trump wants to “declare victory,” the Strait of Hormuz could remain closed for weeks, given the reluctance of shippers to risk passage and the logistical challenges the US may face in organizing a safe convoy.
3. A resolution might not end risk-off trade. Even in a scenario where the White House wishes to pursue a swift resolution, it could take at least another week for the US to complete their objectives, and then Iran could spend at least another week escalating the conflict to improve its own negotiating position. Oil prices could climb higher throughout this period, with tanker traffic still minimal and insurance coverage unresolved.

Given the rapid degradation of Iranian military capabilities and the US's desire to avoid a prolonged period of higher energy prices, we think there are practicalities and incentives that speak against open-ended conflict. We would expect oil futures to fall quickly once there is greater visibility on an end to hostilities and a potential resumption of normal oil flows. History also suggests short-lived oil price spikes rarely inflict lasting economic damage.

Still, risks of higher energy prices materially affecting the growth and inflation outlook have risen, and the increased complexity of the conflict means we expect market volatility to stay elevated in the near term.

How do we invest?
For investors who are already well diversified and have the temperament and the ability to stay invested for the long-term, even if markets tumble in the short term, the strategy should be simple: stay invested. We do not think that this crisis will have a meaningful impact on where markets trade over the longer run.

Those with a shorter-term focus have to prepare for market volatility to potentially get worse before it gets better, emphasizing the importance of diversification and portfolio hedging.

Equities
Investors concerned by the potential for a more sustained period of equity market weakness can consider capital preservation strategies, which can cushion part of the fall in stocks in return for sacrificing a degree of upside. While such protection becomes less appealing as implied equity volatility increases, there is a window of opportunity to lock in more attractive terms at present, since longer-term implied equity volatility remains relatively low, reflecting continued confidence that the US-Iran conflict will not drag on. Of course, investing in capital preservation strategies requires careful consideration of several factors, including often limited liquidity. But for investors seeking sustained equity exposure into 2026 and beyond while limiting their potential losses if interest rate or equity volatility picks up further, capital preservation approaches may offer a flexible solution.

Bonds
Markets outside of the US have moved to price in rate hikes. However, we don't expect central banks to change policy due to the heightened uncertainty. We believe investors should ensure adequate exposure to quality fixed income, specifically high grade government and investment grade corporate bonds, which can help reduce portfolio volatility and limit the impact of shocks.

Alternatives
We believe alternative investments still have a valid role to play in portfolios as both a source of differentiated returns and as potential portfolio diversifiers. But current market turbulence warrants a review of positioning, including liquidity, and a bias toward both diversification (strategy, sector and region) and selectivity. In hedge funds, we believe strategies like discretionary macro, equity market neutral, and multi-strategy platforms are best placed to mitigiate the downside risks while taking advantage of policy shifts, large price moves, and volatility dislocations. We stay positive on merger arbitrage for now but acknowledge that the strategy may perform less favorably if deal activity slows or economic sentiment weakens. Equally, the uptick in private equity deal and exit activity may stall if escalating uncertainty weighs on corporate activity. And in direct lending, we continue to urge strict selectivity with a bias for higher-quality, larger-cap, sponsor-led deals and would avoid riskier and growth-sensitive underwriting in the lower-middle markets and below. The potential for extended oil shut-ins, however, reinforces the case for developed market core and core-plus infrastructure assets given their stable, inflation-linked cashflows, in our view, which make them particularly resilient to stagflation environments.

Investing in alternatives comes with unique risks and drawbacks that investors must consider, including illiquidity, high fees, and the use of leverage.

Commodities
Gold is commonly seen as a traditional "safe-haven" asset amid geopolitical unrest. However, its historical behavior during conflicts is more nuanced than the widespread belief of an immediate and persistent increase in value. In fact, we view gold less as a direct defense against Middle East conflict (oil is a better hedge) and more as protection from the monetary and financial effects that wars can cause—especially when those effects include falling real interest rates, worries about currency debasement, or concerns over elevated levels of government debt. As such, we maintain our recommendation to buy the dip in gold at USD 5,000/oz or below.
Additionally, investors with a long-term outlook may wish to capitalize on any downturns in industrial metals to strategically increase their allocations, particularly in copper given its persistent demand growth and ongoing supply constraints. We continue to believe that implementing a more active investment strategy, as opposed to passive exposure, can facilitate effective navigation of the current divergence between the energy segment and other areas.

Currencies
Near-term dollar strength is likely to persist amid continued Middle East tensions and energy supply disruptions, especially if upcoming US inflation data surprises to the upside; a further spike in energy prices could push EURUSD back toward the 1.10-1.12 range. However, we do not expect a full repeat of 2022, when EURUSD fell below parity, as we still expect the conflict to be relatively short-lived given rapid Iranian military degradation and US incentives to avoid prolonged high energy prices ahead of midterm elections. With FX volatility likely to remain elevated, investors should manage currency allocations and consider hedging tools to mitigate risk; currency risk has historically added around 6 percentage points to total portfolio risk, according to the Global Investment Returns Yearbook. We continue to favor the AUD, NZD, NOK, CNY, and select high-yielding EM currencies in global portfolios.