Today the Iran war has begun, with joint US-Israeli strikes on Iran now underway, and significant Iranian retaliation in the region too and going by news reports, the scope of the conflict appears vast. Unlike the 12-day war in June, this confrontation could prove longer and more intense. As a result, this round carries more threats to oil prices and the global economy. Because this war has no end objective beyond removing the current Iranian leadership. And till the point it does not happen, expect maximum pushback from Iran via all channels including Strait of Hormuz. There is no exit route for the current Iranian leadership & hence by the time, they are replaced, there will be repercussions for energy as well as risk assets globally. We looked at various alternate post war scenarios and realised that 3/7 led to Brent prices surging above $100 levels. The current geopolitical risk premium is roughly $5-$6 per barrel which can easily go to $20-$25 levels in case Iranian exports (currently 1.5 mbpd) halt or Strait of Hormuz gets attacked by current Iranian leadership. We believe this new wave of war is bigger, broader, and messier than previous episodes, such as the June war. The gap between attacks and retaliation has also narrowed: in previous waves, it took days; today, it’s hours. And the arena is already wider covering various countries in the middle east. The Iranian system may survive an initial US strike. Toppling governments is hard, especially with no US boots on the ground. Hence, we believe that it is highly probable that not only Islamic Republic survives in the first few days, it escalates the defence response to attacks on energy infrastructure in middle east as well as strait of Hormuz. 20% of global oil, condensates and petroleum products transit through Hormuz. Also about one-fifth of global liquefied natural gas trade also transit the Strait, mainly from Qatar. So the next question is how long can Iran close Strait of Hormuz? We believe it might be temporary as US forces would ultimately be able to reopen the waterway. US naval vessels could escort commercial oil tankers akin to Operation Earnest Will in the 1980s, where the US Navy protected Kuwaiti oil tankers from Iranian attacks and mines during the Iran-Iraq War. US warships and aircraft could fire upon attacking Iranian ships. The US could sink Iranian vessels blocking the Strait with air- and ship-launched missile attacks. But US efforts to reopen the route would come at a cost: both financial and in capabilities. A direct military clash could further escalate and also risk casualties. And reopening the waterway wouldn’t prevent Iran from trying to close it again. Nonstop instability would continue to affect shipping. This raises shipping insurance costs, freight costs as well as the underlying crude price too. Summary: We believe Iran's current leadership wont go with out a fight. Today’s Israel-US attack on Iran might be drawn into a long-drawn war of minimum 2-3 weeks before the current leadership is either taken out militarily or there is an internal revolt. Till then we will Brent moving higher to $90-100 levels, gold testing $6000 levels and S&P500 testing 6000 levels. 10yr UST yields might push lower towards 3.85 but beyond this level, it might not drop further. Post the initial risk off, there might be massive selling in US assets as inflation fears take centre stage. DXY might strengthen initially but finally fall. This war could not have come at a worst time. The market positioning was tilted in favor of long risk assets before the war began today. Equities might correct significantly as dip buyers vanish and systematic models drive markets lower via momentum driven strategies. In short it might get worse before it gets better.
