Review of four crude oil shocks: market may not have fully priced in a war with Iran.

The analysis pointed out that the market has underestimated the supply shock caused by the interruption of oil transportation in the Strait of Hormuz. This crisis has significantly increased the prices of most commodities, and it seems difficult to resolve in the short term. The market originally viewed it as a temporary geopolitical event, but it has now evolved into a real supply shock. This crisis has brought stagflation risks: it has raised overall inflation rates and suppressed demand, as households are increasing their spending on necessities like heating while reducing spending on discretionary goods. This is a harmful combination for the market, increasing the possibility of simultaneous selling of bonds and stocks. For stocks, this means higher input costs and lower cost pass-through capacity, leading to profit margin compression. Inflation drives up yields, and the corresponding hawkish stance change by central banks exacerbates this situation. The strengthening of the US dollar further amplifies this effect, especially for energy-importing countries and emerging markets. To evaluate the market volatility that the Iran conflict may trigger, a recent study analyzed the relationship between asset prices and commodities during the past four commodity supply shocks (1973 oil embargo, 1979 Iranian Revolution, 1990 Gulf War, and 2022 Russia-Ukraine war). Based on the current trend of the commodity index BCOM, these beta coefficients indicate that the market adjustment amplitude is much larger than the current pricing. The valuation gaps for many assets are quite significant. Relative to the BCOM trend, US breakeven yields, UK yields, and precious metals' valuations seem to be too low. Stock prices in most regions other than the US and Latin America do not seem to fully reflect downside risks, with emerging markets facing the greatest risk. These regional differences reflect the fact that Asian and European economies mainly rely on energy imports, while the US and Latin America rely on energy exports. Of course, there are structural differences compared to previous episodes. Most notably, the US became a net energy exporter in 2019, reversing the relationship between the US dollar and commodity prices. The US dollar now benefits from both safe-haven demand and improved trade conditions (although the average beta values shown in the table are obscured by the US being a net energy importer in the previous three events, resulting in negative beta values). Taking a more direct look at the impact of the Russia-Ukraine war, Brent crude oil prices rose by about 32% from the invasion to the peak more than three months later. The US dollar index initially reacted with a lag, as the market needed to assess its economic impact, but eventually rose by 15% several months later. This time, Brent crude oil prices have risen by about 56% since the outbreak of the war, while the US dollar index has only increased slightly above 2%. Regional factors are also crucial. In 2022, European stock markets are most sensitive to rising energy prices due to their direct dependence on Russian energy; in 1990, the impact on Asia was more significant. Today, Asia is more reliant on commodity shipments through the Strait of Hormuz, so its downside risk seems greater. Regarding interest rates, US 10-year Treasury yields increased in all four periods, although there is a significant difference in their beta coefficients. Existing data shows that breakeven yields tend to rise sharply with worsening inflation, while real yields reflect a balance between slowing economic growth and policy tightening expectations. Policy responses also confirm this point. In these events, the Fed did not cut rates; instead, it raised rates three times, and in 1990, despite being in an easing cycle, it paused rate cuts. Fiscal policy may provide some support to the economy and stock market in the short term during these events, but as most developed economies are facing deficit pressures, fiscal policy is likely to be accompanied by rising yields, limiting its positive impact on risky assets. The market seems reluctant to fully digest the negative impact of rising energy prices. As Simon White pointed out, commodity investors may be more pessimistic about geopolitical risks than financial asset investors. Although market sentiment has softened in recent days due to energy infrastructure becoming a target of attack, the forward curve still indicates that the market expects future energy prices to decline. This has created a clear contradiction. Either commodity prices fall, validating the current pricing, or the macroeconomic impact begins to show in the data. In the latter scenario, both bonds and stocks will face risks, either due to sharp price adjustments caused by adverse news or more gradual adjustments as expectations change.