The macro re-pricing of the US-Iran conflict: Is a stagflation crisis similar to the 1970s repeating?

As the US-Israel-Iran conflict escalates, shipping through the Strait of Hormuz is significantly disrupted, with about 20% of global oil and LNG supplies at risk of interruption. Brent crude oil quickly surged above $80, while diesel, shipping rates, and war risk insurance costs soared in tandem. Energy crack spreads widened, reflecting tighter supply in refined products. Currently, the market oscillates between short-term military friction and long-term strategic blockade scenarios, with inflation expectations and Federal Reserve policy paths as key variables.

Looking back at history, the 1973 Yom Kippur War, oil embargo, the 1979 Iranian Revolution, and the Iran-Iraq War triggered global energy supply shocks twice, doubling oil prices within months. U.S. CPI rose to double digits, stock markets sharply retreated, and real bond yields fluctuated wildly. Subsequently, under Federal Reserve Chairman Paul Volcker’s aggressive tightening, the U.S. suppressed inflation at the cost of high unemployment and deep recession, navigating a difficult stagflation crisis. A core question now is whether this round of conflict has the macroeconomic conditions to replicate the stagflation chain of the 1970s.

In our January 29 article, “Sharp Oil Price Fluctuations: Re-emergence of Geopolitical Risks in Pricing,” we noted that currently, “low oil prices and high inventories significantly reduce domestic U.S. concerns about energy-driven inflation, sharply lowering the cost of targeted, surgical strikes. Oil prices have not yet exerted obvious pressure on U.S. inflation or household living costs, reducing U.S. concerns about the consequences of high oil prices in Middle Eastern affairs, and making them more willing to take aggressive actions in sanctions and military deterrence.”

However, the U.S. surgical strike on Iranian leaders did not end the conflict as swiftly as the attack on Venezuelan President Maduro. Iran has declared readiness for a prolonged war. Meanwhile, the U.S. stock market’s mild reaction indicates that the market has not fully priced in the risk of a long-term blockade of the Strait of Hormuz. This subdued response is not accidental but aligns with typical market behavior: only when local geopolitical events impact macro variables like economic growth and inflation do markets react persistently and broadly; if there are no spillover effects on the economy, shocks tend to remain confined to directly affected assets and do not propagate widely (see our January 8 article, “What Conditions Trigger Intense Market Reactions to Geopolitical Events?”).

However, some Asian economies like Japan and South Korea are more vulnerable to a closure of the Strait of Hormuz. Coupled with previously strong momentum trends, risk aversion has led investors to take profits, resulting in significant capital outflows and a stampede-like plunge. European markets, impacted more severely by soaring oil and natural gas prices, also reacted more intensely than U.S. markets.