The Iran Conflict and Its Impact on Global Markets

The Iran Conflict and Its Impact on Global Markets

The coordinated US and Israeli military operation against Iran has produced the largest energy supply disruption in modern history, dwarfing every prior oil shock on record. With the Strait of Hormuz effectively shut and oil flows down more than 90% from normal levels, the world is dealing with a 17.6 million barrel per day supply hit, roughly 17% of total global supply and 18 times larger than the disruption caused by Russian sanctions in April 2022. Markets have responded with sharp moves in energy, rates, and equities, but we think the full range of second-order effects has not yet been priced. The conflict raises fundamental questions about the durability of Middle Eastern energy infrastructure, the capacity of strategic reserves to bridge the gap, and the interaction between an oil shock and an economy already contending with tariff drag and fading fiscal support.

Published 20 March 2026. Analysis based on institutional research available at time of writing.

The Scale of the Supply Disruption

The Strait of Hormuz is the single most important oil transit chokepoint in the world. In 2025, approximately 19.6 million barrels per day of crude oil moved through the Strait, along with significant volumes of natural gas, refined products, and petrochemical feedstocks. The coordinated military operation has reduced those flows by roughly 97%, with the latest four-day moving average showing just 0.6 million barrels per day passing through, compared to the normal 20 million barrels per day.

To put the 17.6 million barrel per day supply hit in historical context, this is the largest oil supply shock ever recorded. The numbers speak for themselves when compared to prior disruptions.

• The 2022 Russia and Ukraine conflict produced a supply hit of roughly 5% of global production, with prices rising approximately 60% from three months prior to peak
• The 2011 Libyan civil war disrupted about 2% of global supply, with prices rising roughly 40%
• The 1990 Iraqi invasion of Kuwait hit roughly 6% of global supply, with prices rising about 90%
• The 1980 Iran-Iraq War disrupted approximately 5% of supply
• The 1973 oil embargo, often cited as the benchmark energy shock, disrupted about 5% of supply with prices rising roughly 100%
• The 2026 Iran conflict has produced a peak supply hit of approximately 16%, with prices already up roughly 90% from three months prior

The disruption extends well beyond crude oil. Gas and refined product tankers have also largely stopped transiting the Strait. Chemical products from the Middle East, including ammonia, urea, phosphate, sulfur, polyethylene, MDI, caustic soda, and methanol, have been severely disrupted. The Middle East holds major global export shares in several of these commodities, which means the ripple effects will show up in fertiliser costs, plastics manufacturing, and industrial chemical supply chains worldwide.

Flights to and from Gulf countries were significantly reduced in the initial phase of the conflict. Some recovery has occurred, but commercial aviation in the region remains well below normal levels.

Why Alternative Routes Cannot Fill the Gap

There has been some optimism about the ability of alternative pipeline routes to compensate for the Strait closure. The two primary alternatives are the Saudi East-West Pipeline, which can move crude from the Persian Gulf coast to the Red Sea port of Yanbu, and the UAE Habshan-Fujairah pipeline, which bypasses the Strait entirely by routing oil overland to the Gulf of Oman coast.

Both routes are operational and are currently being used to redirect some flows. However, their combined spare capacity is only approximately 1.8 million barrels per day. Against a disruption of 17.6 million barrels per day, this covers roughly 10% of the shortfall. The arithmetic is straightforward and unfavourable.

The US government has taken several steps to address the supply shortfall, but each has limitations.

• The Treasury released 12 million barrels from the Strategic Petroleum Reserve (SPR) on March 19. The SPR currently holds 415 million barrels with a theoretical maximum draw rate of around 4 million barrels per day for the first 30 days, declining to around 2 million barrels per day after 60 days. However, SPR stocks are already near record lows following the 2022 and 2023 drawdowns, and would fall to just 33% capacity by mid-year under the next emergency draw plan
• Treasury waived sanctions on Russian crude and refined products on water as of March 12, which is estimated to release approximately 130 million barrels of supply. A general license to purchase Venezuelan oil was also issued
• A Jones Act waiver was granted, which normally prohibits shipping between US ports by foreign-built or foreign-flagged vessels. The waiver signals the administration’s willingness to temporarily break with longstanding policy to address energy costs

Even with all of these measures combined, the supply gap remains enormous. The fundamental problem is that no combination of pipelines, strategic reserves, and sanctions relief can replace nearly 18 million barrels per day of production that the global economy was built around receiving.

The Geopolitical Picture and Why Resolution Is Not Imminent

Geopolitical analysts and regional experts have offered assessments that suggest this conflict will not resolve quickly or cleanly.

Sanam Vakil at Chatham House has emphasised that Iran views this conflict as an existential struggle. The regime will not seek an end until it receives guarantees for its long-term survival. This framing is critical because it means Iran’s threshold for accepting a ceasefire is far higher than markets may be assuming. Adding complexity, Iran’s new Supreme Leader Mojtaba Khamenei, who has received relatively little international attention, is unlikely to seek peace. The IRGC (Islamic Revolutionary Guard Corps) is not merely a military organisation but runs significant portions of the Iranian economy and society, meaning any military degradation of the IRGC has domestic economic consequences that further entrench resistance. While there are historical parallels with the 2015 JCPOA nuclear deal, the difference this time is that the regime’s legitimacy itself is at stake.

Dennis Ross at the Washington Institute for Near East Policy has argued that the US can claim a military victory regarding the Strait, but cannot restore oil flows to normal. Ross sees a real divergence between US and Israeli war strategy and goals, with conflicting narratives emerging about how the two countries came to operate together in direct military action for the first time. Israel’s recent territorial and strategic acquisitions have diminished Iran’s conventional threat capability for at least five years, but this creates a situation where the two allies may have different views on when the mission is complete.

Retired Vice Admiral Kevin Donegan has focused on the military dimension, noting that objectives are being achieved in degrading Iran’s ballistic missile and drone capabilities. The IRGC used the Strait of Hormuz as an economic chokepoint, one of its key pillars of regime power. However, Donegan has highlighted several sobering realities.

• Mines laid in the Strait from non-military vessels are unpredictable and create hazards that persist well beyond any ceasefire
• While the threat from ballistic missiles has been contained, Iran retains storage sites and production facilities that could reconstitute capability
• Military convoys can ensure safe passage for some vessels, but can only restore approximately 20% of normal flows at best
• There is an important distinction between capability and capacity. The US Navy has the capability to escort ships through the Strait, but does not have the capacity to escort enough ships to restore anything close to normal commercial traffic flows

US Political Pressures and the Timeline Question

The US administration has set public expectations for a short conflict. On March 5, the President indicated the operation would conclude “in the next few weeks.” By March 17, the language had shifted to “a couple more weeks, not much longer,” implying a total war duration of four to six weeks from the initial strikes.

This timeline creates a political constraint that cuts both ways. If the conflict resolves on schedule, the economic damage is manageable. But if it does not, the administration will face mounting pressure from an electorate that did not broadly support the operation. The lack of broad public backing for the war has not yet weighed significantly on Congress, but this could change rapidly if energy prices remain elevated through the second quarter.

The political dimension matters for investors because it influences the pace and scale of the policy response. The SPR drawdowns, sanctions relief on Russian and Venezuelan crude, and Jones Act waiver are all signals that the administration is willing to use every available lever to manage energy costs. But each of these tools has limits, and the more aggressively they are deployed, the fewer options remain if the conflict extends beyond the stated timeline.

The Inflation Shock, Headline Versus Core

The inflationary impact of the supply disruption is significant but varies substantially by region and by the distinction between headline and core measures.

At the global level, the shock is expected to add 0.8 percentage points to headline inflation in the baseline scenario, rising to 2 percentage points in the severely adverse case over the next twelve months. The regional distribution is highly uneven.

• Europe faces the largest headline inflation impact due to its reliance on imported natural gas for home heating and electricity generation. Higher natural gas prices flow through to consumer energy bills within weeks, not months
• India is also severely exposed as a major crude oil importer with limited domestic production capacity
• China sees the smallest impact because its energy mix is more heavily weighted toward domestically produced coal and electricity
• Canada and Latin America actually benefit as energy exporters, receiving positive terms-of-trade shocks

Core inflation, which strips out food and energy, is affected through second-round channels as energy costs flow through to transport, manufacturing, and services pricing. The core impact is meaningfully smaller.

• Baseline scenario adds approximately 0.2 percentage points to global core inflation
• Severely adverse scenario adds approximately 0.5 percentage points

Historical parallels from 1990-91 (Gulf War), 2000 (oil price spike), and 2011 (Arab Spring disruptions) are reassuring on one dimension. In each of those episodes, the inflation shock from energy supply disruptions remained largely confined to headline measures and did not trigger a persistent wage-price spiral that broadened into core inflation. The critical difference from the 2021 experience is that demand growth today remains moderate with no fiscal stimulus surge, and supply disruptions are concentrated in Middle Eastern energy rather than broad-based across the economy.

However, the starting point for inflation in 2026 is higher than in several of those historical episodes. Tariffs have already contributed 76 basis points to core PCE through February 2026, which accounts for roughly three quarters of the 1 percentage point overshoot versus the Fed’s 2% target. This is largely a one-time price level effect rather than persistent inflation, but it does mean the Fed has less room to look through the energy shock than it would if inflation were already at target.

The Growth Shock That Markets Have Not Fully Priced

We think the more significant risk is the growth impact, which tends to materialise with a lag of three to six months after a major energy supply disruption. The initial market response focuses on prices, but the real economic damage shows up later in consumer spending, industrial production, and corporate earnings.

At the global level (excluding the Middle East), the growth drag ranges from 0.4 percentage points in the baseline scenario to 1.2 percentage points in the severely adverse case. The distribution across regions is extremely uneven.

• Europe and India bear the largest growth impact as major energy importers with limited domestic production
• The UK is also significantly exposed
• Canada and Latin America see positive growth effects as energy exporters
• The US impact is contained relative to Europe but is compounded by other headwinds

For the US specifically, the timing of this conflict is particularly challenging. Several forces are converging simultaneously.

• The fiscal boost from pandemic-era stimulus and the Inflation Reduction Act is already fading in the second half of 2026
• The Iran conflict has triggered approximately 60 basis points of tightening in financial conditions, equivalent to the impact of two to three conventional rate hikes
• Tariff drag continues to weigh on trade-sensitive sectors
• Combined, these forces are expected to push US GDP growth to just 1.25 to 1.75 percent annualised in the second half of 2026, which is meaningfully below potential GDP growth of 2.3 percent

The MENA region faces an even more severe outlook. GCC countries could see a potentially bigger growth decline in non-oil GDP from the Iran conflict than they experienced during the pandemic. Saudi Arabia faces a potential 2026 decline of roughly 4% in non-oil GDP, with other GCC nations looking at declines of 2 to 8 percent.

The Labour Market and the AI Interaction

Unemployment projections have shifted in response to the conflict. In the baseline scenario, US unemployment is expected to rise to 4.6 percent. In the severely adverse scenario, unemployment could reach 4.8 to 4.9 percent.

An underappreciated dynamic is the interaction between cyclical labour market weakness and the accelerating deployment of artificial intelligence in the workforce. AI labour displacement effects have been modest so far, but are expected to increase through 2026 and beyond. Historical patterns from past automation cycles show that firms tend to accelerate adoption of labour-saving technology during recessions, when they are under the greatest pressure to find efficiencies. If the conflict tips the economy toward recession or near-recession conditions, the pace of AI-driven labour displacement could accelerate at precisely the worst time for workers.

The 12-month forward recession probability has been nudged to 30%, which is back to where it sat for most of the second half of 2025. This is elevated enough to demand attention without being a base case forecast.

The Fed’s Dilemma and Bond Market Overshoot

The Federal Reserve faces a classic supply shock dilemma. Higher energy prices push inflation up while simultaneously dragging growth down. The bond market has reflected this uncertainty with dramatic swings in rate expectations.

• On February 27, markets were pricing roughly 60 basis points of rate cuts for 2026
• By March 20, that had swung to pricing 5 to 10 basis points of rate hikes
• This represents a swing of nearly 70 basis points in rate expectations in less than a month

Institutional research still expects two 25 basis point cuts in September and December, arriving at a terminal rate of 3.0 to 3.25 percent. The logic is that while the inflation shock delays cuts, it does not derail the easing cycle entirely because the growth impact will ultimately force the Fed’s hand. Core PCE inflation is forecast at 2.5% by year-end, which still implies 50 basis points of core disinflation from current levels.

The March FOMC meeting had a hawkish flavour, with only one dissent in favour of a cut and less emphasis on job market risks than in prior meetings. But the probability-weighted funds rate path from leading research desks sits approximately 100 basis points below current market pricing one year out, suggesting the market has overreacted to the inflationary dimension and underweighted the growth risks.

The bigger tail risk is a recession or near-recession scenario that triggers more aggressive cuts than the baseline two. If unemployment rises faster than expected or financial conditions tighten further, the Fed could be forced to cut more aggressively even with inflation above target.

Long-Term Supply Risks and Infrastructure Damage

Perhaps the most underappreciated risk is the potential for lasting damage to Middle Eastern oil production capacity. Analysis of the five prior largest oil supply shocks reveals a pattern that should concern anyone forecasting a quick return to normal.

• In historical precedents, production four years after a major supply shock remains over 40% below pre-shock normal levels
• This persistent shortfall is largely driven by physical damage to oil infrastructure and the collapse of investment in maintenance and expansion during conflict periods
• Iran and seven other Persian Gulf countries produced 30% of world crude in 2025
• Approximately 25% of the region’s crude is produced offshore, and the engineering complexity of offshore operations means that ramp-up times are significantly longer than for onshore production

If the current conflict causes even a fraction of the infrastructure damage seen in prior episodes, the implications for long-term oil supply are substantial. OPEC spare capacity could help bridge the gap if deployed quickly, but the political dynamics of deploying that spare capacity in the middle of an active conflict involving multiple OPEC member states are far from straightforward.

What We Are Watching

The range of outcomes from here is genuinely wide, and we think investors should be positioned for that uncertainty rather than making concentrated bets on a specific resolution timeline. The key variables we are monitoring include the following.

• Duration of the Strait closure, and specifically whether the mid-April target for reopening holds or slips
• The pace of SPR drawdowns and whether additional international reserves are released
• Second-order effects on European and Asian growth data over the coming months
• The Fed’s communication at upcoming meetings, particularly any shift in emphasis between inflation and employment risks
• Physical damage assessments of Iranian and Gulf state energy infrastructure as more information becomes available
• Mine clearance progress in the Strait, which will determine how quickly commercial traffic can resume even after a ceasefire

We continue to favour diversified portfolios with meaningful energy exposure as a hedge, quality companies with pricing power and low sensitivity to input costs, and a cautious stance on duration in fixed income until the inflation and growth picture clarifies. Cash flow and balance sheet strength matter more than usual in an environment where the cost of capital is rising and the growth outlook is deteriorating simultaneously.

If you would like to discuss how global macro trends might affect your portfolio, request a callback or call us on 1300 889 603.