GM. This is Milk Road Macro, breaking down the oil spike, the war scenarios, and what they mean for risk assets next.
This is where we take a bird's-eye view of the most important factors across the global economy and risk asset markets.
We’ll explore what’s happening right now and what might happen next.
And there’s only one thing happening right now.
The biggest energy supply shock in history.
This is an incredibly complicated and dynamic situation.
But one that could have massive implications for the global economy and asset markets.
In this edition, we will:
- Take a sticky deep dive into oil - what’s happening and what does it mean?
- Consider the potential scenarios ahead for the Iran war and the Strait of Hormuz.
- Look in detail at what this means for asset markets moving forward.
- Analyse whether this situation has the potential to be a “cycle killer”.
- Refresh our understanding of the U.S. economy - the economic regime has changed.
- Look in detail at investor positioning and what we can learn from this.
This is a deep dive into the most important factors driving markets.
As always, we have a lot of charts to get through (50+).
So, let’s get going…
The most important chart in the world
There’s really only one chart that is important right now - and that is the price of oil.
We are not only currently experiencing the biggest energy supply shock in history, but it’s the biggest by a wide margin.
The crude oil market is confusing because there are many different “oil prices” across the world, and particularly at the moment, there’s a historically wide spread between different oil prices.
Brent crude oil is specifically European oil, but it’s considered the “global benchmark” because it directly prices 63% of the global spot crude export market.
If you were to look at one oil chart as “the oil price”, it should be Brent crude oil.
So, here’s the picture with Brent crude oil, alongside its potential effects on the global economy if prices are sustained at certain levels.
Since the war began, we’ve blasted through the “mostly manageable zone” and zig-zagged between the “headwind zone” and the “stagflation zone”.
Price sustaining in the “danger zone” ($120-$150) is where commentary will likely shift from “serious macro drag” to “heightened global recession fears” - but we haven’t touched these levels, yet at least.
Price sustaining above $150 (“major global shock regime”) for any sustained period of time is when a recession would be pretty much assured in many countries across the globe, with the economic effects likely rippling out across the world like a shockwave.
The problem here is that the Strait of Hormuz, one of the world’s most vital trade chokepoints, is effectively closed.
Pre-war, 20M barrels of oil per day (20% of global demand) passed through the Strait.
Now, virtually nothing.
Many policy measures are being put in place across the world to cushion this, including releasing strategic stockpiles, releasing commercial stockpiles, and rerouting some Gulf oil through pipelines.
But most of these measures are temporary, and even in the best-case scenario, the daily oil shortfall is still roughly 10M barrels of oil per day, every day (10% of global demand).
Goldman Sachs estimates the current daily shortfall to be 11.4M barrels of oil.
That is a huge gap - more than the total oil consumption of the UK, France, Germany, Spain, and Italy combined.
We are looking directly down the barrel of a very serious situation.
The Strait of Hormuz needs to be reopened, or the oil price will likely continue to rise over time…
…until it rises high enough to cause demand destruction - as the global economy starts to stumble and less oil is required as economic growth deteriorates.
So there are two cures here: it’s either the Strait reopens, or the global economy rolls over.
U.S. government officials are actively considering the prospect of oil prices surging to an unprecedented $200 a barrel, and are assessing what the potential impacts might be, according to Bloomberg.
We also need to consider that some lasting damage has already been caused, even if the Strait is reopened tomorrow.
Due to limited storage capacity, many Gulf states have now practically “shut in” all energy production, so that means incredibly complicated systems need to be “switched back on”, which can take weeks or even months.
Also, a substantial amount of energy infrastructure in the region has been heavily damaged or destroyed, and getting this broken production back online will take years.
According to the French Government, 30-40% of Gulf refining capacity has been destroyed, and full repairs could take three years.
Finally, countries across the globe are likely to be incentivised to start hoarding more oil when the Strait reopens, as uncertainty will likely still be prevalent, which will be another added tailwind for the oil price.
So, at this point, a reopening of the Strait likely does not mean everything instantly reverts back to how it was before the war, and energy prices probably won’t return to where they were previously.
According to a note from Goldman Sachs commodity specialist Tallulah Adams:
“Specialist clients increasingly believe (1) a higher floor is being set across several commodity markets given destocking and infrastructure damage, and (2) commodities can trade materially higher with no further escalation as the current imbalance can create acute tightness.”
This situation is a giant mess.
Not only will oil prices likely continue to rise if the Strait remains closed, but physical oil scarcity is now emerging across the globe and will continue to sweep the world like a tidal wave.
All oil that was already in transit pre-war has now largely reached its destination, so shortages will start to be materially felt moving forward.
The physical scarcity shock unfolds sequentially rather than simultaneously - a rolling supply disruption moving westward, dictated by shipping times.
Asia and Africa are already feeling the squeeze as pre-war cargoes have largely dried up, and Governments are already putting policies in place to attempt to cushion the blow, including rationing and work-from-home advice.
Asia is by far the most heavily directly affected region, accounting for the majority of oil flows from the Gulf.
This is a big problem for many Asian nations, including Japan, South Korea, Taiwan, Thailand, Vietnam, India, and others.
South Korean President Lee Jae Myung urged citizens to "save every drop of fuel," and “actively participate in energy-saving movements.”
Myung added: "The current crisis is not a passing shower that quickly subsides, but rather a massive storm whose duration is uncertain, making it all the more severe."
Europe is likely to feel the impact by mid-April, but the shock here is not as severe and shaped more by rising costs and competition with Asia than by outright shortages.
Still, about 1.1M barrels per day of imports are at risk in Europe, not an insignificant amount, and some European gasoline is already being diverted towards Asia, where margins are more attractive.
The U.S. is last in line by virtue of geography and is also probably the least directly affected.
With longer voyage times and substantial domestic production, direct physical shortages are unlikely in the near term.
Instead, the impact will be felt mainly through higher prices and dislocations in refined product markets - especially in California.
Patrick Pouyanne, chief executive officer of TotalEnergies SE, said:
“It’s clear to me that if this crisis lasts more than three or four months, it becomes a systemic problem for the world. We cannot have 20% of the crude oil, which is exported globally, stranded in the Gulf and 20% of the LNG (gas) capacity stranded, without any consequence.”
A higher oil price doesn't just raise the prices at the pump - it works its way through everything.
Petrochemicals feed into plastics, fertilisers (food), and pharmaceuticals, among many other things.
Higher fuel prices hit every product that moves by truck, ship, or plane.
Then, workers facing higher commuting costs and grocery bills demand higher wages.
Each channel operates on a different lag - pump prices move in days, airline tickets in weeks, grocery shelves in months, wages in six to twelve months.
The global annual budget for oil was $2 to $3T pre-conflict.
It’s now moving to $5 to $8T, and that extra spending must be funded by curtailments in spending elsewhere.
If the Strait stays closed, the world will have to significantly reduce its oil and gas consumption - but probably not before prices spike to a level that forces consumers and businesses to fly, drive, spend, and consume much less.
There is an argument to be made that the U.S. economy specifically is:
- Less reliant on oil than it used to be.
- Less directly affected by this energy supply shock than other nations.
But if we get into an extreme situation where economic recessions start to crop up in heavily affected countries and then ripple across the world, this is likely not good news for the U.S. economy over time.
America does not exist in a vacuum.
And while oil is the big story, this major disruption is not exclusive to oil.
Large amounts of many other vital substances are transported through the Strait, including 20% of the world’s natural gas, a third of the world's fertiliser (sparking potential food production concerns), and a large chunk of the world’s helium (which is vital for the manufacturing of semiconductors).
What’s next?
I want to make it clear that I have no idea what happens next with the war.
Nobody does.
If somebody says that they do know, they are lying.
However, that doesn’t mean we can’t look at what might be likely to happen next and what the potential scenarios are.
The first thing I would say is that we’re in the “fog of war”, so it’s incredibly difficult to know what to believe and what not to believe.
Likely, both sides of the conflict are publicly lying about multiple things for various strategic reasons.
But what is the consensus on when things might calm down, and when the Strait will reopen?
According to Deutsche Bank, 51% of clients expect a ceasefire in April, while 22% think a ceasefire will occur in May.
According to speculators on Polymarket, there is a 24% chance of a ceasefire by the end of April, rising to 45% by the end of May.
And there is a 13% chance that Strait of Hormuz traffic returns to normal by the end of April.
While Iran has so far effectively weaponised the Strait of Hormuz as a big piece of leverage, the incentive to keep the Strait closed likely won’t last forever.
There will probably come a point where the leverage mostly disappears, as widespread and lasting global economic damage sets in.
But Iran will likely want to hold out for as long as possible.
According to Marko Papic at BCA Research:
"I am not sure that it is in Tehran's interest to hold out forever. If they usher in a 1970s-style global recession, the gloves are off. They, too, have an interest in negotiating somewhere within Area N. As close to R Point as possible."
So, how close are we to the “R Point” right now?
I don’t know - it’s very tough to gauge.
But I think we’re probably closer than many people realise.
Meanwhile, on the U.S. side, there are also big incentives for President Trump to find a swift exit.
According to several polls, a minority of Americans support the war in Iran, and an even smaller portion would support “boots on the ground”.
Similarly, according to a Reuters/Ipsos poll, only 29% of the country approves of President Trump’s economic stewardship, with this number cratering in recent weeks.
This is the lowest rating in either of Trump’s terms and lower than any rating under Joe Biden.
So, what are the latest noises from both sides of the war this week?
Let’s whip through the most important headlines.
President Masoud Pezeskhian said the Islamic Republic has “the necessary will to end this war,” but only with guarantees “to prevent the recurrence of aggression,” according to Iran’s state news agency.
It’s unclear what these “guarantees” might be.
But Iranian officials reportedly previously set out a 5-point plan, including assurances to prevent further fighting, war reparations, and sovereignty over the Strait of Hormuz.
Earlier this week, President Trump told the New York Post that the U.S. is “not going to be there too much longer,” adding that the waterway would open “automatically” after the U.S. leaves.
But later, he said he would leave it to other nations to resolve issues with the Strait of Hormuz.
Then, in a social media post, Trump said “Iran’s New Regime President” has “just asked the United States of America for a CEASEFIRE!”
He added: “We will consider (a ceasefire) when Hormuz Strait is open, free, and clear. Until then, we are blasting Iran into oblivion or, as they say, back to the Stone Ages!!!”
Iran’s foreign minister said Trump’s claims about a ceasefire were “false” and “baseless”.
Despite claims to the contrary from Trump, U.S. intelligence shows that only about one-third of Iran’s missiles have been destroyed “with certainty” so far, according to Reuters, citing “five sources”.
Prime Minister of Israel Benjamin Netanyahu said Iran was no longer an “existential threat” to Israel, for the first time since the war started.
That is perhaps him preparing the Israeli public for the end of hostilities and claiming success.
Finally, on Wednesday, Trump gave a highly anticipated primetime speech that lacked detail and a precise timeline for any potential exit from the war or a reopening of the Strait, pledging more aggressive strikes “in the next two to three weeks”.
So, if you can make sense of all the information above - let me know…
But my mantra for now is “follow the troops, not the tweets”.
The U.S. has been slowly moving troops into the Middle East in recent weeks, and now a total of more than 50,000 military personnel are reportedly deployed in the region.
This includes several thousand elite Marines and members of the 82nd Airborne, which may foreshadow some kind of ground invasion.
That is an incredibly expensive measure to take if it’s only a negotiating tactic.
If the U.S. wants to attempt to reopen the Strait by force, a ground invasion will likely be needed - probably covering Iranian islands in the Persian Gulf and parts of the Iranian coastline.
According to speculators on Polymarket, there’s a 63% chance that U.S. forces will enter Iran by the end of April.
The Pentagon is preparing for “weeks of ground operations in Iran”, the Washington Post reported.
The UAE is preparing to help the U.S. reopen the Strait by force, according to the Wall Street Journal.
Iran is reportedly ready to deploy more than one million fighters if the U.S. launches a ground invasion, according to Tasnim News Agency, citing an IRGC source.
A ground invasion would be a significant escalation.
Risk asset markets would likely react negatively to this, unless it is extremely swift and clinical with troops stabilising the situation rapidly (I give this low odds).
Meanwhile, Iranian-backed Houthi rebels in Yemen formally joined the conflict, launching missile strikes on Israel.
This introduces a second maritime pressure point in the Red Sea, which has the potential to send oil prices even further higher.
Houthi officials have said they might attempt to close a second vital trade waterway: the Bab el-Mandeb Strait.
This would be yet more bad news for energy prices, with JP Morgan analysts predicting a Bab el-Mandeb Strait closure could add $20 to an already elevated crude oil price.
Looking ahead, if the war continues, the “nuclear” option for the U.S. is an export ban on oil and gas.
The U.S. produces a lot of energy, so it can theoretically just keep all of this production trapped inside America.
In this scenario, you’d probably see U.S. crude oil prices (WTI) dive lower, with other crude oil prices across the world (like Brent) surging higher.
This would be a good option for the U.S. domestically, but potentially disastrous for its relationship with allies.
Particularly after President Trump told European countries to buy oil and gas from the U.S., instead of Russia.
But how is the war affecting markets?
Let’s look deeper…
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WHAT’S LEFT INSIDE? 👀
- How is the war affecting markets?
- Is this situation a “cycle killer”? Or can the cycle survive?
- How’s the U.S. economy shaping up? What economic regime are we currently in?
- There have been big moves in investor positioning and flows. What can we learn from this?
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