Diplomacy or Conflict? Analyzing the U.S.-Iran Conflict and Its Economic Impact

As the US war with Iran enters its 5th week, all eyes are on the conflict in the Middle East.

Now we are looking at US stocks rallying this morning, and this does come on the heels of a Wall Street Journal report saying that Trump is considering exiting the war without reopening the Strait of Hormuz.

At the same time, we are looking at oil futures higher above the $100 a barrel level with WTI.

103 and not surprisingly we are looking at US gas climbing to hit an average of $4 per gallon for the first time since August 2022.

Also breaking, China and Pakistan publishing a joint five-point initiative that is aimed at restoring peace in the Middle East.

While plenty of uncertainty does abound, and joining us this morning to weigh in is Matt Gertken, Senior Vice President at BCA Research.

Matt, good morning.

A lot of moving parts here, so I'm glad you're joining us today.

We're getting conflicting reports on diplomacy and the Trump administration says Iran is eager to deal behind the scenes that Iran does publicly call the US demands excessive as well as illogical.

So do you think real negotiations are actually taking place and what is the key takeaway here?

Hi Remi, thanks for having me.

Well, the key takeaway right now is that the Iranians have used a drone to strike a Kuwaiti tanker off the coast of Dubai, and the US has used bunker buster bombs to hit a sort of arsenal that the Iranians were storing in Isfahan.

And so we have a significant escalation in the conflict.

The US also reportedly did an attack on an island right in the Strait of Hormuz that's critical for Iran's ability to oversee shipping.

So the actions on the ground are showing a continued conflict even though the president does seem inclined to try to contain this oil shock before the election.

Yes, and as you mentioned, it is a midterm election year and all of us are keeping an eye on the economy, especially as energy prices remain elevated.

So with world leaders actually concerned about what this means and what Means for rates and urging an end to the conflicts to save not just developing economies but also more energy dependent economies.

How high do you think oil prices can spike before we see actual massive demand destruction?

Yeah, we have to use scenarios here because there's a scenario in which the conflict escalates in a major way, like the United States goes and attacks the sources of revenue for the Iranian regime such as at Karg Island.

And in that case, the regime would retaliate against more shipping or regional production, and we'd have a larger shock and oil would go back up to $120 per barrel on Brent, maybe even have a melt up phase if you're seeing sort of an unlimited exchange of fire hitting critical infrastructure.

On the other hand, you could just see a scenario where we, we, we retest that $120 level, but then we come back down because negotiations are succeeding, and by successful negotiations, all you need to do is have President Trump declare victory and have the Iranians stop attacking shipping and energy production.

And then finally you could have a scenario where the oil price falls, you know, back down to say $80 per barrel, but I do think the floor is a lot higher than what it was before the war, around $60 because countries are going to be hoarding oil as soon as they get the chance in the fear that the conflict will re-erupt later in the year.

And I, and I think it very well could erupt later in the year if diplomacy manages to work this month.

Yeah, and speaking of which, what are the potential scenarios for de-escalation that you are looking at?

I give roughly a 1/3 chance for de-escalation over a 12 month period, and the reason I say that is because remember that the United States right now is not trying to topple the Iranian regime.

It's focused on destroying its missiles and drones and its navy and its ability to block the strait.

But the US isn't opposed to knocking the regime out in the future, and the only thing really holding the president back is his concern about the election, which is over on November 3rd.

And for the Iranians' part, they have a suspicion that the Americans will continue to return to the attack simply because they are within.

American power.

I mean, there's not much defense that they can use against the skies.

There's not much defense they can use against American bombing and surgical strikes against leadership.

Their only leverage right now is Hormuz, and if they lose that leverage, then they're completely prone.

So I think there's just a lack of security guarantees on offer, and I don't think that Pakistan and China, I mean, of course it's good that they're trying to mediate a ceasefire here.

But I don't think that they can provide the security guarantees that will make Iran sure that they will not be attacked in the future, and I don't think they can convince the United States to give up its its prerogative to attack Iran if it thinks Iran is up to bad behavior again.

And finally, Matt, we have about 60 seconds here, so I do want to get your take on what this means for the markets because here on Wall Street we're paying attention to what the bond market is doing in addition to other asset classes.

So for now, what is the likeliest economic endgame and how exactly should investors position for it?

Well, I think the problem is that we could have a stagflationary moment where the lingering effects of this shutdown, and especially if the energy shutdown lasts longer.

You know that that's going to subtract from consumer real consumer incomes and then therefore real consumer spending, and it'll slow down the US economy where the labor market had already started to show some signs of weakness and could see further weakness if spending declines.

And so that would then remove one of the probably the main driver of this global business cycle.

It doesn't necessarily mean we have a recession, but it does mean we have a slowdown.

And meanwhile you're getting higher food and fuel prices.

It's obviously sort of causing that.

So what the issue then is that it's not great for stocks.

It's not great for bonds.

You could have bond yields be a little bit higher and a little stickier on inflation and fear of central banks hiking rates, and then you could also have the stock market coming down in expectation for lower spending and lower investment.

And so it's, it's um it's a we will have to leave it there for today as we are ending the show now.

So thank you so much for joining me, Matt, and as always, appreciate your time.