Our three scenarios for the Iran conflict

Due to the geopolitical turmoil, financial markets are in risk-off mode. As a result, we witness some normal risk-off market behaviour, but not all reactions are as expected.

In response to the war, energy prices have soared, especially now that the transportation of oil and LNG through the Strait of Hormuz has come to a standstill. At the same time, equity markets dropped. Asian and European markets, which are more dependent on energy from the Middle East, went lower. US equities, however, declined less. Indeed, the outperformance of US equities after the start of the war underlines investors’ perception of the US equity market as having a more defensive character than other regions in times of uncertainty. On a similar note, the US dollar strengthened, reaffirming its role as a safe-haven asset. We cannot say that from gold. While we expected the gold price to rise, it actually dropped. This was likely the result of investors taking profit to cover losses elsewhere. Meanwhile, Bitcoin is up, after large losses in recent months.

Expected rate cuts of the Federal Reserve (Fed) are being pushed further into the future by the market, as sustained higher energy prices can lead to higher inflation. As a result of expected higher inflation, bond yields have risen. This is negative for government bonds (bond yields and prices move inversely), which typically function as a safe-haven asset in times of unrest. Risk premia (country spreads and spreads on corporate bonds) have also risen this week. Finally, volatility, as measured by the VIX index, has risen since the start of this week. But even though this index is now at above-average levels, the increase does not indicate a sense of extreme fear in markets yet.

For investors, the main question is how the conflict will develop from here and what will be the impact on financial markets? We distinguish three scenarios, which are mainly determined by the duration of the conflict and the level of energy prices.

Scenarios ABN AMRO

1. ‘As is’ for the coming weeks before calming down, with an oil price¹ at or above USD 100
2. A prolonged conflict of three month or longer, with an oil price at or above USD 130
3. Situation improves quickly, with an oil price at USD 80

‘As is’ for some weeks

The first scenario we see as most likely, with a probability of 50%. In this scenario, attacks from both sides continue for some weeks, but less than a month. The Strait of Hormuz remains closed for shipping and some oil & gas facilities are also closed. Although there will be no long-lasting impact on production facilities, production of oil and gas will be reduced due to the closure of oil & gas refineries. After a few weeks, there will be slow improvements back to a normalisation of energy production and transport. The ‘as is’ scenario will have a slight impact on inflation and hardly any on global economic growth.

A prolonged conflict

The second scenario is the worst-case scenario, with a probability of 25%. In this scenario, the conflict will take three months or longer. Attacks from both sides continue and intensify in the region. The Strait of Hormuz is closed for an extended period of time and oil & gas facilities are damaged. The war has an impact on pipelines, production facilities and ports, which require more time to repair. There is no de-escalation of the conflict in the coming months, with higher inflation as a result.

Situation improves quickly

The third scenario is the most optimistic one, with a probability of 25%. In this scenario, attacks will be reduced within the next two weeks, due to diminished capabilities of Iran and/or if President Trump declares victory and scales back US attacks. The Strait of Hormuz opens and oil & gas production resumes, quickly leading to normal production and transportation. This scenario will have a negligible impact on global economic growth, which will strengthen further during the year.

All scenarios see an initial negative impact for equities, higher oil prices, a stronger dollar, higher gold prices and increased volatility. However, total impact is more nuanced (see table 1)

Our most likely scenario – ‘As is’ for some weeks – sees room for equities to fall further, with US markets and the sectors energy, materials and healthcare outperforming. Bond prices will drop due to inflation fears (higher yields). Oil reaches could reach USD 100 and the VIX could spike to around 35. However, once the normalisation process starts, we also expect markets to rebound quickly.

The worst case scenario – A prolonged conflict – sees a more significant fall of equity prices. Again with US markets and the more defensive sectors such as energy, consumer staples and healthcare outperforming. In this scenario, bond prices still fall, as we expect concerns on inflation will outweigh concerns on growth. Oil reaches at least USD 130 and the VIX could spike to 40 or higher.

The most optimistic scenario – Situation improves quickly – sees equities recovering quickly. Emerging markets and Europe will outperform, in reversal of market movements earlier this week. On a sector level, financials and industrials will outperform other sectors. Bond prices will also rise as inflation concerns will disappear. Oil reaches USD 80 or can even fall lower towards USD 60 and the VIX reaches 25.

Although all scenarios see a negative impact on investment portfolios, certainly in the initial response, we recommend investors not to make hasty investment decisions. In this context, we also want to note that we do not make changes to our economic growth forecasts for now. (Economic growth is an important driver for company profits, and, therefore, for equity prices.) The reason for this is that it is difficult to assess how long the conflict will last. And for now, we believe the effects are mainly felt via higher inflation, which does not immediately translate to lower economic growth.

We acknowledge that financial markets are nervous and the situation is fluid. At the moment, we do not know how the conflict will play out exactly. This means we can slide from one scenario slowly into the next. That said, when the situation improves, markets will respond quickly. Therefore it is essential not to make hasty investment decisions.

We also want to emphasize that the world economy is strengthening and earnings are expected to grow by double digits in 2026. Although growth and company earnings may eventually be affected by the impact of the war, we do come from a position of strength. Moreover, the US and Europa are on track with fiscal stimulus, and the market still expects the Fed to lower its policy rate at some point this year. We therefore retain our modest overweight in equities and our neutral view on bonds. From a risk perspective, we also have positive view on gold.

Also read the market commentary of 2 March 'Strikes on Iran: what does this mean for investors?'