The Everyday Amidst the Chaos

The term ‘uncertainty’, widely discussed this year, is causing a stir once more. The ongoing conflict between Israel and Iran has now involved the US. Over the weekend, American bombers struck three locations in Iran to disrupt its nuclear ambitions.

While US President Donald Trump [declared a ceasefire agreement on Monday] claims he has achieved his goals and reveals no intent for further strikes, the next steps largely depend on Iran’s reaction [Trump accused both Israel and Iran of violating the ceasefire on Tuesday].

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This could indicate an end to the conflict or merely a new beginning.

Iran may target several American military installations in the region. In a desperate move, it could disrupt maritime traffic through the Strait of Hormuz, a vital route carrying nearly one-fifth of the world’s oil shipments.

Trump faces the challenge of managing both a military and trade war, highlighting political complexities as he promised to keep the US out of foreign disputes while presenting global economic risks.

Black gold

Wars inflict human suffering, but investors are primarily focused on the Middle East due to oil.

Historical context shows that the Arab Oil Embargo of 1973 and the Iranian Revolution of 1979 severely disrupted markets and hampered the global economy. More recently, we observed a rise in global inflation following Russia’s full-scale invasion of Ukraine.

Brent crude oil price

Recently, oil prices surged as traders grew concerned about potential supply issues. When markets reopened on Monday, prices briefly surpassed $80 a barrel—the highest since January—although they remained within a two-year trading range. The chart below indicates that Friday’s closure aligned the oil price with its long-term average in real terms.

Geopolitical tensions caused a sixfold price spike during the 1970s, and 2008 saw another steep increase due to fears that strong demand would outstrip diminishing supply (despite real-world scenarios not nearing ‘Peak Oil’).

Notable price surges occurred in 1990 during Iraq’s invasion of Kuwait and again in 2022 amid Russia’s assault on Ukraine, while America’s 2003 invasion of Iraq had minimal effects.

Real oil prices

Rising oil prices will inevitably increase global fuel costs, which could exacerbate inflation. Although these two factors are distinct, heightened fuel prices may prolong inflation if businesses pass the added costs to consumers—known as the secondary impact—or could simply decrease disposable income (much like the effects of Trump’s tariffs). Oil prices act as a global tax; as they increase and maintain high levels, businesses and consumers will have less spending power for other purchases. While producers may benefit, overall, higher oil prices would hinder global economic growth.

It is essential to recognize that the world economy is less dependent on oil than it was in the 1970s, but a significant spike in oil prices could inflict damage similar to that era. If the Strait of Hormuz were to be obstructed, for instance, oil prices could plummet to the $130 per barrel level seen post-Russia’s 2022 invasion of Ukraine.

Read: How a cornered Iran could disrupt global oil trade

Russia deliberately manipulated energy prices as a weapon in 2022, especially by curtailing gas supplies to Europe, causing damage to economies dependent on piped gas that couldn’t be instantly replaced by maritime gas.

Moreover, Russia and Ukraine, as major grain exporters, contributed to a surge in food prices in 2022, adding to global inflation already on the rise as the world sought to recover from Covid-19 lockdowns.

This recovery enabled firms to pass on higher costs to customers, allowing them to maintain or even enhance profit margins.

Some termed this inflationary surge as ‘greedflation’ or ‘profit-led inflation’. Regardless of terminology, it suggests that companies have pricing power—something not obviously present in the current environment. Thus, 2022 serves as an imperfect comparison for the present situation.

Another critical distinction is that global oil supplies were tighter in 2022, whereas they are less constrained now. In fact, just before Israel’s strikes on Iran, Brent crude was trading around $65 per barrel. Future price movements will depend not only on Iran’s actions but also on responses from other significant oil producers, particularly the OPEC cartel.

OPEC has spare production capacity, and nations like Saudi Arabia and the UAE are not particularly sympathetic toward Iran. They are unlikely to desire higher oil prices that could incentivize US shale producers to increase output.

Furthermore, a global economy strained by US tariffs may struggle to absorb sustained higher oil prices, ultimately leading to reduced oil demand—an undesirable outcome from their perspective.

With sanctions and years of underinvestment, Iran’s oil exports account for only about 2% of the global total. Unlike Russia in 2022, Iran lacks the motivation to weaponize energy prices, aside from gaining leverage in future dealings and recuperating lost pride. With few allies, China is likely its closest major export market, and China is not keen on inflated oil prices.

Additionally, there are doubts regarding Iran’s capacity to sustain attacks on regional oil infrastructure, given its weakened military, stagnant economy, and an unhappy populace.

Trade war and peace

This implies that while vigilance is necessary, the trajectory of the global economy this year and into the next seems more influenced by traditional economic policies than by geopolitical turmoil.

There has been encouraging news regarding tariffs, but significant uncertainties linger. The US and China have prolonged their trade truce after recent negotiations. Although details remain scarce, there appears to be a shared interest in avoiding extreme tariff outcomes. Similar results are likely in negotiations with other countries, although these are still underway with varying degrees of success.

The 90-day halt on implementing ‘reciprocal’ tariffs concludes in two weeks, leaving nations like South Africa awaiting updates on the tariff levels they may face.

Market consensus indicates that US tariffs will be higher than at the start of the year, albeit not as elevated as previously threatened on April 2.

This suggests that American consumers will likely face rising prices in the future, while local businesses may experience tighter profit margins.

Consequently, other countries may lose some export revenues. Current evidence is limited, but economic data appears somewhat complicated due to prior stockpiling by many businesses and consumers seeking to avoid price hikes.

The initial tariff announcement and its subsequent suspension on China could trigger another wave of stockpiling. Additionally, a clampdown on US immigration affecting labor supply complicates the evaluation of the economy’s underlying health. A clearer picture will likely emerge in the coming months.

This perspective is also shared by the US central bank, the Federal Reserve, which convened last week (before the strikes on Iran) to discuss interest rates. The Fed’s dual mandate includes full employment and price stability. Practically, this means trying to maintain low unemployment while keeping inflation near 2%. The Fed can mark a check next to the first part of its mandate, as reflected in their post-meeting statement indicating a robust US economy with low unemployment. Conversely, inflation is viewed as “somewhat” elevated.

Headwinds

Looking ahead, the economy is facing headwinds from tariffs, likely putting additional pressure on the labor market. Simultaneously, tariffs could disrupt the downward trend in inflation (as might rising energy prices). This is evident in the quarterly economic projections summary from Fed officials, often referred to as the dot plot, which indicates a diminished growth outlook compared to March alongside higher inflation expectations.

Fed Median Summary of Economic Projections

Consequently, the Fed’s dual mandate faces conflicting pressures, resulting in a decision to maintain stable interest rates.

As Fed Chair Jerome Powell remarked during the press conference: “Ultimately, the cost of tariffs will be passed on to consumers to some extent. We acknowledge this impending reality and aim to observe its impact before drawing premature conclusions.”

Yet, some voices within the Fed advocate for taking earlier action before the economy deteriorates further. There is a risk that the Fed may delay, seeking clarity on tariff effects while the economy’s health declines. This poses a greater threat to markets than developments in the Middle East and necessitates careful monitoring.

As for the South African Reserve Bank, Governor Kganyago may feel fortunate that he scheduled the next Monetary Policy Committee (MPC) meeting for July 30.

This timing allows him and his colleagues to assess the stabilization level of oil prices and the rand-to-dollar exchange rate. As of Friday, the rand price of oil was still 7% lower than a year ago, causing no alarms, though this could change in the coming days.

Oil in rands

The MPC will also consider June’s inflation data. May’s inflation was likely at its lowest, logged at 2.8%, but has remained below the Reserve Bank’s target range of 3% to 6% for three consecutive months. It is expected to trend upward and hover near the 4.5% target in the medium term, unless there are drastic global changes. No formal announcement regarding an alteration of the inflation target has been made yet.

Risks and opportunities

Three final considerations warrant attention concerning the volatile situation in the Middle East.

First, the geopolitical landscape is shifting. If the US takes military actions against smaller nations—regardless of justification—without international community support through the United Nations, what prevents larger countries, like China, from acting similarly concerning Taiwan? Much like Trump’s tariffs, this reflects the unraveling of the global order established by America over the last 80 years.

Second, this situation embodies both risks and opportunities. Energy serves as a prime example. The global reliance on the Middle East for oil highlights our ongoing dependence. However, every time security fears regarding oil supplies bubble up, it drives global exploration for alternative energy sources and oil from more stable regions.

The upheavals of the 1970s spurred advancements in fuel-efficient vehicles, a proliferation of nuclear power plant construction, and the discovery of oil fields in the North Sea and elsewhere.

Today, electric vehicles are set to capture market share, while nuclear energy is gradually regaining traction and solar and wind power continue to expand. There are also promising prospects for drilling in nations like Namibia. This transition holds extensive economic ramifications.

Oil is traded and transported internationally; conversely, renewable energy often focuses on local applications. Therefore, the emphasis extends beyond energy sources to include the entire economic ecosystem that supports them.

The global economy will invariably demand energy. For example, artificial intelligence thrives in energy-intensive data centers, not in isolation.

Finally, while such geopolitical events dominate headlines and provoke market volatility, long-term equity market returns derive from less dramatic factors—the profitability of global companies and the intent to remain invested, leveraging the power of compounding. The tumultuous events of recent weeks do not change this essential truth.

Izak Odendaal is an investment strategist at Old Mutual Wealth.

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