The Threshold For An Oil-Driven Risk-Off Move

Geopolitical events don’t usually cause a sustained market reaction (indeed, we’ve already seen that in 2026 with Venezuela and Greenland), but, as Deutsche Bank notes this morning, the exception is when the geopolitical event has a macro channel to affect markets, and events in Iran are a prime example of that.

With equities tumbling this morning - after yesterday's put-selling driven dip-buying -  Deutsche points out that sustained S&P 500 drawdowns in recent decades (above 15%) driven by oil shocks have historically required at least one of the following, and none of these historical conditions has yet been met:

1. Large oil price spike: An oil price spike of at least +50-100% that is sustained over several months.

2. Broader macro damage: The shock is big enough to tip an already-slowing economy into recession or cause a meaningful economic slowdown (e.g. 1990 Gulf War).

3. Hawkish response: The shock forces a sharp, hawkish pivot from central banks to fight the resulting inflation (e.g. 1979, 2022). 

The critical question over the days ahead will be if one of these boxes is ticked.

Set against the last 60 years, today’s oil shock appears comparatively modest so far, and when oil shocks have generated meaningful risk-off moves before, it’s usually been when we’ve seen prices increase by at least 50%, if not more.

It’s a similar story if we look at the one-day change. Whilst it was the biggest one- day jump since 2022, it was hardly a once-in-a-generation move, having had 55 others of that magnitude since 1990.

Using the framework above can help explain why events over 2023-25 failed to cause a more meaningful market reaction, despite plenty of geopolitical turbulence.

• First, the oil price spikes over 2023-25 were reversed fairly quickly, and prices were on a downward trajectory anyway, reaching a multi-year low just before Christmas.

• Second, we haven’t yet seen broader macro damage or an end to data resilience. Indeed, when we have seen data wobbles (as in the summer 2024 recession scare) then risk assets have turned very quickly. 

• Third, we haven’t yet seen a substantial repricing of central bank reaction functions. Although pricing has become more hawkish, markets still consider a hike from the Fed or ECB as a tail risk rather than the baseline.

So far today, none of these conditions has been met.

1. We are yet to see an increase in oil prices above +50%, let alone one that is sustained.

2. We are yet to see a meaningful data deterioration, although that would take some weeks to become apparent.

3. And we are yet to see markets price in rate hikes from major central banks like the Fed and the ECB.

Those will be the crucial questions for the days ahead.

Professional subscribers can read much more from Deutsche Bank's Sales & Trading team here at our new Marketdesk.ai portal