Middle East conflict exceeds expectations, Wall Street adopts the "Ukraine" script

As the certainty around the duration of the Iran conflict decreases, investors are turning their attention to the “Russia-Ukraine conflict” script for market guidance.

Many traders are revisiting their trading strategies from the outbreak of the Russia-Ukraine conflict in 2022, betting that this week’s surge in energy prices will push inflation higher, leading to a sustained dollar strength and weakness in bonds and stocks.

Although markets largely dismissed last year’s 12-day US and Israel strikes on Iran, investors are now concerned that this conflict could last longer.

“I know all too well, using the 2022 script,” said Jordan Rochester, head of fixed income, FX, and commodities strategy at Mizuho Bank in London, according to Bloomberg on March 5. “It’s both a war and a logistics crisis—a trade shock—20% of global energy supplies can’t leave the region, even if only temporarily.”

The unpredictability of the conflict means sentiment could change rapidly, and some analysts say it’s premature to assume impacts on the scale of 2022. Media reports on Wednesday suggested Iranian officials have contacted the CIA and proposed negotiations, easing some pressure on stocks and halting the dollar’s rally. Oil prices retreated some of their gains.

Market reactions echo 2022

Since the Middle East conflict began, market responses have closely mirrored those in the days following the Russia-Ukraine outbreak. Brent crude has surged above $82 per barrel, natural gas has hit its highest level since 2023. Global stock indices fell 2%, and South Korea’s Kospi experienced its largest decline ever. Concerns about inflation eroding the Fed’s room to cut rates and US debt’s traditional safe-haven status caused US Treasuries to fall. The dollar strengthened against all major currencies.

“Investors are starting to feel nervous,” wrote Bilal Hafeez, chief market strategist at Macro Hive Ltd, in a report to clients on Tuesday. “On Monday, they expected the Middle East conflict to be brief, and US stocks even closed higher that day. But today, the market is starting to digest the possibility of a longer-lasting conflict.”

He noted that if the 1990 Gulf War serves as a template, this could mean oil prices rising to as high as $100 within a month, and the S&P 500 consolidating or falling more than 10%. If bond performance mirrors past conflicts, the 10-year US Treasury yield could rise to between 4.25% and 4.6%, and the dollar against the euro and yen could climb further.

Matthew Haupt, hedge fund manager at Wilson Asset Management, is also looking for clues from the 2020 Russia-Ukraine conflict. “We saw pure liquidation—somewhat, even safe-haven assets aren’t safe,” Haupt said after closing long oil positions this week. “The current script is similar to what we saw during Ukraine, but this time it’s about oil, and the risks could become even greater.”

Inflation Shock Fears Resurface

The main concern in the market is that Middle East turmoil will transmit inflation shocks globally, similar to 2022 when the Russia-Ukraine conflict disrupted supply chains and prompted governments to increase spending to protect industries and consumers. EU governments alone pledged over €500 billion ($582 billion) through borrowing.

At that time, broad dollar strength indicators rose 6% from February 24 to year-end. Fears of inflation caused the two-year US Treasury yield to jump more than 2.8 percentage points in the same period, while the 10-year yield rose 1.9 points. Gold declined, and the S&P 500 fell 19% that year—the worst since the 2008 financial crisis.

Despite European natural gas prices surging up to 85% since Friday, they remain well below the peaks seen in 2022. However, with Russian energy still constrained, any incremental supply loss could have a significant inflation impact, making this risk potentially higher for Europe. Citi strategists say that a conflict lasting more than two weeks could push natural gas prices from around €55 per MWh to €100.

Yields in the UK and Europe surged this week as traders ruled out the possibility of the Bank of England cutting rates and even began considering ECB rate hikes. This repricing reflects concerns over inflation and the potential for governments already increasing defense spending to borrow more.

Higher oil and natural gas prices have pushed the euro below $1.16, the lowest since November. Options briefly reflected this pressure, with one-week euro sentiment hitting its most bearish level since 2022.

Escalating Geopolitical Risks

Howe Chung Wan, head of Asian fixed income at Principal Asset Management, which manages over $590 billion, is also watching the 2022 energy disruption script, though he expects the risk of war involving Iran to be more significant.

“Ukraine-Russia oil impacts are mainly in Europe, but it’s broader,” Howe said, having taken profits in emerging market bonds. While smaller conflicts previously focused on Israel and Iran, “if the Gulf Cooperation Council intervenes militarily, we could see a major shift in Middle Eastern geopolitics.”

JPMorgan also compares this situation to 2022. Strategists including Nikolaos Panigirtzoglou wrote in a report that while retail investors showed patience—avoiding selling stocks in the first month of the Ukraine war—they were less patient with bonds.

“After a month, once it became clear the war would be prolonged, triggering more persistent oil price/inflation shocks, retail investors started to sell stocks and bond funds persistently,” they said.

Not everyone is ringing alarm bells

Certainly, not everyone is sounding alarms. Deutsche Bank strategists note that oil price increases cannot be compared to some larger crises in history (like 2022 or the Gulf War).

Analysts say that for recent energy shocks to cause the S&P 500 to decline more than 15% sustainedly, oil prices would need to surge at least 50% to 100% over several months, along with broader macro disruptions and hawkish responses from central bank leaders.

“Current energy shocks are almost incomparable to 2022,” said Erik Nelson, macro strategist at Wells Fargo. He advised clients to downplay this instinct and buy euros, targeting a rebound above $1.19.

Goldman Sachs chairman David Solomon said it would take weeks to understand the full picture, but so far, market reactions have been “moderate.”

Nonetheless, many traders remain cautious. Veteran Rajeev De Mello, with four decades of market experience, believes caution is warranted, and the Russia-Ukraine conflict remains one of the best guides for investors.

“Investors are forced to reduce portfolio risk, decreasing stocks and corporate credit,” said De Mello, global macro portfolio manager at Gama Asset Management SA, who has cut some bets on European, Japanese, and emerging market equities this week. “The lesson from 2022 is that investors shouldn’t buy the first dip immediately, as more declines are expected.”

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