While global headlines fixate on tactical manoeuvres, the financial markets are exhibiting a delayed reaction that borders on the delusional. The localised spat that is being assumed can easily turn into something bigger and nastier. A full-blown Middle East war that has already shifted from worrying to accelerated escalation to loss of control in two weeks.
The central question is simple: Is the market fundamentally underestimating a conflict that is a strategic threat to our global energy architecture?
The World is Your Lobster or TACO for Two
The operation has moved beyond a surgical strike and is morphing into a giant lobster pot, easy to enter but nearly impossible to exit without sustaining terminal damage. It is not easy to TACO in a kinetic war. Indeed, as Le Shrub put it takes two to TACO.
The potential tipping point lies at the apex of Iranian energy: Kharg Island. Handling 90% of Iran’s oil exports, the vast majority of which flow to China. Large energy installations like Kharg Island have historically been off the agenda precisely to avoid global contagion. Targeting such assets now suggests a level of desperation and the loss of control among the US/Israeli coalition.
The defanging of Iran is nothing like the operation in Caracas. We are dealing with a country the size of Western Europe with a regime that has spent 50 years preparing for this specific strategic purpose: attacking the ‘Great Satan’ and its regional allies.
Playing Russian Roulette in Dire Straits
The Straits of Hormuz are currently the site of a high-stakes game of Russian roulette. While the Iranians are technically letting their own carriers and select partners (such as Pakistan-registered vessels) pass, the artery is effectively severed.
Dad joke warning: Which reminds me: Question, how do you stop a circus? Answer, go for the juggler. But I digress …
Traffic Collapse: A choke point that typically sees 30 to 40 very large crude carriers (VLCCs) a day is now seeing “literally not even a handful.”
The Insurance Barrier: The Straits aren’t “closed” by a physical blockade alone, but by the prohibitive cost of insurance. The principal deterrent is the catastrophic financial loss if a carrier is struck.
Energy Spikes: Brent crude is currently trading around $107—up 20% in two weeks—with volatility swinging between $90 and $115. Even more dire is the situation in Europe; European landed LNG has more than doubled since January, soaring from 25 Euros to as high as 67 Euros.
Equity Illusion & Stretching Elastic
There is a disconnect across asset classes, suggesting equity investors are whistling past the graveyard waiting, as Michael Every might put it, for the delusion of mean-reverting markets to kick in. While the S&P 500 is down a mere 2%, more sensitive markets like the FTSE 250 and AIM 100 are down 5% and 8%, respectively.
The US dollar has become the safe haven of choice, climbing 4% to 5% since the first bombs fell in Iran. This allows the US to export pain to the rest of the world, particularly Europe and emerging markets. However, the domestic political cost is high: rising pump prices are crucifying the MAGA movement. Bubba’s bill for fueling the truck is causing problems.
The piece of elastic metaphor is critical here. If bond investors truly believed we were returning to a 1970s-style stagflationary environment, yields would not be sitting below 5%. In 1975, the US 10-year yield was between 15% and 16%. The fact that the 10-year US Treasury is only up a few basis points indicates the market still believes this operation is a short-term blip. But elastic only stretches so far before it snaps.
The Death of the Volcker Option and the Fed’s Squeal
In the 1970s, Paul Volcker broke inflation by taking rates to 20%. That is no longer a policy option. Today’s extreme levels of national debt mean that any significant rate hike calls into question the US Treasury's very financial viability.
Central bankers are like rabbits staring into the headlights of an oncoming car. They are paralysed, knowing they need to move in two directions: raise rates to fight energy-driven inflation while also cutting them to save a collapsing economy.
Adding to this volatility is the overt political language now emerging from the Federal Reserve. Chair Jay Powell’s recent refusal to leave office until the Department of Justice (DOJ) completes its investigation into his behaviour further signals the breakdown in central bank independence. We are entering an era of fiscal dominance in which the Fed is no longer an independent arbiter but a political actor under siege. And soon, Bessent will have his buddy, Kevin Warsh, installed as the new Chair.
The $150 Oil Wall: The Deflationary Breaking Point
While the initial spike in energy is inflationary, it eventually reaches a “breaking point” at which it becomes violently deflationary through demand destruction.
The global economy comes to a halt when oil prices are between $150 and $200 per barrel. At this price point, demand is not merely inelastic—it is destroyed. This is the ultimate trap for central banks: the energy crisis forces an economic collapse so severe that the only remaining response is to cut rates sharply and re-engage in massive quantitative easing to prevent a depression.
An Upside-Down World: Bitcoin’s Surprising Stability
We are living in interesting times when the lifeblood of the physical economy, crude oil, is more volatile than Bitcoin, which has actually increased in value in dollar terms during this escalation, maintaining a level of stability that oil cannot match. When the physical energy market becomes more speculative and volatile than Bitcoin, it serves as a stark warning that the traditional world order is fraying at the seams.
Conclusion: Berlin Wall or a Suez Crisis?
The global economy is currently suspended between two starkly different outcomes. The bulls argue that this is a Berlin Wall moment and a successful defanging of Iran, bringing unprecedented stability and security to the Middle East.
However, the alternate future is America’s Suez Crisis. A forced US retreat from this theatre would leave a power vacuum that China, the primary buyer of Iranian crude, is poised to fill. China stands as the major beneficiary of a diminished US presence in the Gulf.
As the piece of elastic continues to stretch, investors must ask: when it finally snaps, which way will the global economy fly? With bond yields like the UK Gilt up 3.5 basis points and the Japan 10-year hitting 2.3%, the cracks are already showing. If the market finally prices in a 1970s reality, the transition from 5% yields to double digits will be anything but graceful. Other outcomes remain possible.
Have a good weekend.
Jeremy
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