Playbook For Iran Risk Boils Down To Disruption

Authored by Michael Ball, Bloomberg macro strategist,

US military action on Iran would result in sudden-yet-tradeable risk aversion. The negative markets impulse only sustains if there’s material disruption to regional oil production and shipping flows around the Strait of Hormuz.

Heightened US-Iran tensions are once again prompting traders to map potential regional developments against risk sentiment and volatility. Oil is typically the initial shock absorber, and then rates and currencies reveal the relative beneficiaries from that move, while equities adjust to any inflation implications.

The crucial questions are (1) whether the stated goal is to accelerate the negotiation process or is about leadership removal, and (2) whether any strikes are described as a one-off or the start of a campaign.

Let’s consider a scenario where the US carries out limited strikes and adopts a de-escalatory stance in the aftermath, implying no sustained disruption to regional production and Strait of Hormuz transit. Relevant precedents include the air strike to take out Qassem Soleimani in January 2020, and last year’s extensive Israeli strikes as part of Operation Rising Lion and US strikes on nuclear sites in Iran that comprised Operation Midnight Hammer.

The typical markets sequence involves a sharp risk-off impulse — oil, gold and volatility higher, equities lower — in the first one to three days.

However, if shipping keeps moving, volatility would soon compress and equities would subsequently recover losses as oil sheds the event risk premium. That dynamic was consistent with the reaction seen in the aftermath of the Soleimani air strike, as the chart below shows.

Meanwhile for Operations Rising Lion and Midnight Hammer, the typical sequence played out about a week prior to the first salvo as markets anticipated the actions, and was reversed within a day of the confirmed initial Israeli strike.

As for the impact on inflation expectations, research by the Dallas Federal Reserve on the potential effects of Operation Midnight Hammer showed that even under a severe shock tied to Hormuz disruption, the initial oil spike mattered less than its persistence.

In contrast, a scenario that involves the goal of replacing Iran’s leadership would result in sustained risk aversion and higher volatility across assets. Regime change is rarely a single event; rather, it’s a period where governance, security and oil policy all get repriced. Even in a so-called orderly transition, markets sentiment would only recover when investors are convinced in the relative stability of future oil flows.

In a chaotic adjustment or prolonged conflict, oil would become structurally more volatile as tail-risk outcomes are attributed higher probability, rather than the simple assumption of elevated spot prices due to lost supply. That would complicate the situation for global central banks, given inflation prints lift with energy prices — even if long-run expectations do not fully de-anchor.

One such example was Operation Iraqi Freedom, which began in March 2003 and lasted more than eight years. Oil volatility jumped early in the conflict, but as the regime-change phase resolved and the global oil market adjusted, including the beginning of the US shale revolution — pricing stabilized.

In considering the latest US-Iran tensions and their impact on markets, the key focus would be the escalation path — which will be obvious from the first strikes.

A telegraphed hit on military facilities followed by a proportional retaliation by Tehran points to talks resuming and volatility fading, while any strike that targets Iranian leadership signals a longer uncertainty window that would keep oil prices and volatility elevated.