Links between geopolitics and the global economy are tangential at best, at least in the short term.
Obviously, in a conflict such as this, the key factor between the two is the price of oil. But even this relationship can be unpredictable. After the 9/11 attacks in 2001, the price of Brent crude oil, the key benchmark, jumped by 5% as markets braced for broader disruptions to supply across the Middle East. Yet, within weeks, oil prices had fallen by 25% as worries about weakening global demand and a possible recession overtook the fears of supply shocks. Similarly, after Russia invaded Ukraine in February 2022, Brent crude surged 30% in two weeks, only to return to pre-invasion levels eight weeks later.
Oil prices are currently roughly 15% higher than they were in early June, before Israel started its strikes on Iran. What happens in the next few weeks will determine whether they push any higher, or if they start to normalise back to where they were.
Research by the European Central Bank highlights the two ways in which geopolitical shocks affect the price of oil and the global economy. In the short term the dominant factor is risk, which is precisely what one can imagine has pushed up the oil price so far. When markets fear disruption to oil production, traders push up the “convenience yield”, or the premium for holding an oil contract. “Rather one in the hand than two in the bush.” This pushes prices higher, at least momentarily. But over time general economic activity and demand factors take over. As happened following 9/11, heightened geopolitical tensions often dampen global demand as uncertainty weighs on investment, consumption and trade. This reduces oil demand and depresses prices.
Of course, this has not always been the case. The oil price shocks of 1973 and 1979 were both followed by recessions in the US. This possibility now cannot be ruled out. The US economy is already battling high interest rates, and the effects of tariffs. Even before the oil price spiked, the business cycle was long in the tooth and a recession was a real risk, even if not most economists’ base-case scenario. This undoubtedly raises the risks. Of particular relevance is the 1981 recession, which was caused by the Iranian Revolution and in part worsened by the Fed having to maintain high interest rates to beat inflation. The parallels with today are unmistakable.
Where does this go now? This depends on four factors.
First, how will Iran continue to respond to Israel, and whether the conflict spreads into a regional conflagration which seriously disrupts the flow of tankers through the Strait of Hormuz. This narrow waterway – just 33km wide at its narrowest point – is the only maritime gateway to the Persian Gulf and handles about 20% of global oil consumption. Its shipping lanes are vulnerable to attack or blockade, such as that attempted by Iran during the Iran-Iraq War of 1980 to 1988, which became known as the “Tanker War” as both sides targeted commercial vessels. Yet even then the strait was never fully closed. Furthermore, should Iran attempt that now, it would incur the wrath of Saudi Arabia and the UAE who depend on the strait for their oil exports. That will further weaken the already fraught relationships Iran has with its neighbouring regional powers.
Either way, Iran has made it clear that it will not be the first side to stop the attacks, and Israel must be the first to halt bombing, before Iran will even consider a ceasefire and negotiation. “If President Trump is genuine about diplomacy and interested in stopping this war, the next steps are consequential,” Iranian foreign minister Abbas Araghchi said on X on Monday. “It takes one phone call from Washington to muzzle someone like Netanyahu. That may pave the way for a return to diplomacy.” The mullahs know that Bibi is after them.
Second, what is the actual objective of Prime Minister Benjamin Netanyahu? Does he actually believe he can enact regime change in Iran, as he has threatened? There can be little doubt that he would like to see Iran’s regime fall. Given its deep domestic unpopularity and internal divisions, that possibility cannot be dismissed. But history suggests that external attacks often prompt populations to rally around their government, not overthrow them. His attacks could have the opposite effects of what he intends. Calls by an Israeli leader for the Iranian people to rise up have little appeal when those same people are being bombed by Israel.
Initial signs are that Israel is preparing for a three- to four-week conflict at least. Given that it now has almost complete air superiority over Iran, with its F16s free to sow terror and eradicate targets at will, it would seem surprising for them to pull out now.
Third will be the reactions of Iran’s authoritarian friends, Russia and China. Will they attempt to prop up the regime and assist its military efforts, or are they wary of being embroiled in the conflict? Russia, stretched thin by its war in Ukraine, lacks the capacity for another intervention like the one that saved Syria’s Assad in 2015. China, for its part, is more interested in buying Iranian oil and selling surveillance technology than getting drawn into Middle Eastern security entanglements.
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One factor that should be remembered is that Putin will not be averse to a drawn-out conflict that pushes up the price of oil; the higher the price at which Russia can sell its oil, the more sustainable is its war economy. While the military partnership signed between the two countries in January falls short of a mutual defence clause, Russia could support Iran indirectly by sending munitions. Indeed, Iran has helped Russia in its war against Ukraine by sending critical drones and missiles.
The final factor is the all-critical role of the US. If there is one constant with President Donald Trump it is that he is an anti-war leader. He sees it as being bad for business. Yet, now the US risks being pulled into yet another costly war in the Middle East. The personal relationship between Netanyahu and Trump is clearly strained, to put it mildly. Trump seeks deals and peace, but Netanyahu’s actions broadside both goals. Being unable to get Netanyahu to desist, Trump is in a lose-lose situation. This could be the moment, along with the ruinous effects of his tariffs, that his administration starts coming off the rails.
Why this is important
It may be true that geopolitics does not normally have an impact on the global economy and markets, but unfortunately these do not seem to be normal times. As this drags on, pulling the actors deeper and deeper into catch-22 situations, and making their actions ever more desperate and less predictable, investors should be aware that the implications for an already teetering global economy are profoundly negative.
For South Africa – reliant on oil imports and already battered by energy crises and high fuel costs – the fallout could be severe. A prolonged spike in oil prices could be the final blow that pushes its struggling economy, already under pressure from trade threats like tariffs, into a recession.
