The US-Israeli attacks on Iran, and the virtual closure of the Strait of Hormuz, have sent oil prices soaring above $100 per barrel. With the war now two weeks old, I consider some of the economic and financial market fallout. As the consequences will increase the longer the conflict continues, the failure of the Trump Administration and Israel to outline clearly their ultimate goals and exit strategy complicates the assessment. Moreover, the United States and Israel may have different plans.

However, the initial combat phase of the previous two Gulf Wars (1990 and 2003) lasted about six weeks. As I do not believe President Trump is willing to accept the economic and political implications of a protracted war, I anticipate this conflict will be shorter than the previous episodes. Indeed, I expect POTUS47 will soon declare victory; suggesting the Iran leadership has been decapitated, its nuclear and missile capabilities have been degraded, and Iran’s proxies have been severly weakened. While such an outcome would hurt Iran, the Islamic revolution would remain in place to rebuild it capabilities potentially. Of course, I could be wrong, and the conflict could continue. The economic pain would intensify. But, at this stage I want to provide some tools to gauge the economic fallout.

Oil Shock: Not as Bad as the Past….Yet

To be sure, the surge in oil prices above $100 per barrel has been alarming. However, when adjusted for inflation, the real (or relative) price of petroleum remains below the levels reached during past shocks (Chart above). The same is true of natural gas quotes, which remain far below those resulting from Russia’s invasion of Ukraine (next Chart).

In addition, in response to previous oil shocks, the world has become more efficient in the use of oil. Indeed, energy intensity — the amount of GDP produced per unit of energy consumed — has risen sharply in recent decades (next Chart). However, the performance of individual countries differs widely. In particular, Europe’s (Japan’s too) energy efficiency is far better than America’s. Also, emerging Asian countries require far more power to produce each unit of output, as their economies are are more reliant on the energy-intensive manufacturing sector. China is a huge consumer of power; however, it’s energy productivity improvements have outpaced the rest of the world in recent decades.

Therefore, the global economy is not at risk of recession….yet. Oil prices would need to remain in the $130-$150 range for three to six months to produce such a downturn. Nevertheless, don’t be complacent. The rule of thumb in the USA is each $10 increase in the oil price will add $0.25 to gasoline quotes. Therefore, with oil prices at $100/barrel, US drivers could soon see pump prices reach $5.00 per gallon. Overall, at his stage, I expect US CPI inflation to accelerate to 3.25%-3.5% by the end of the year. I have already been more cautious than the consensus regarding US GDP growth in 2026.Therefore, I have only trimmed this year’s growth forecast to 1.25%. I expect the consensus will soon cut their overly-optimistic 2.25% projections, at least towards 1.5%-1.75%.

Who’s Most Vulnerable?

The vulnerability to oil price shocks differs widely across countries and regions. Asian economies are most at risk, especially Japan and Korea (Chart above). Within Asia, energy-rich Indonesia and Malaysia are least vulnerable. As much of China’s and India’s power is generated by coal, they appear relatively less at risk to rising petroleum quotes. We will see, however, these nations are more vulnerable to supply embargoes. Therefore, I am reducing my 2026 Asian GDP projection by 1% at this stage.

Europe is the second most at-risk region. Consequently, CPI inflation is likely to rise towards 3% by the end of the year. And, I am cutting my 2026 GDP estimate from 1.5% to 1%. Countries in Latin America differ signficantly. Energy-abundant Brazil, Colombia, and Mexico will fare better than others such as Chile.

Supply Embargo: Closing the Strait of Hormuz

As oil (less so for natural gas) is a global commodity, consumers in all countries will feel the impact of rising prices. However, the effective closure of the Strait of Hormuz, through which 20% of the world’s oil supply is transported, poses particular risks for certain countries.

Once again, Asia is most dependent on Middle East oil producers for their imports. Despite recent purchases from Russia, oil imports from the Gulf account for 50% to 60% of the total in China and India. Other developing Asian economies are similarly exposed to an embargo of physical petroleum supplies from the Middle East. Japan’s nearly complete reliance on Gulf oil imports is most concerning. On the other hand, Europe has successfully diversified its oil purchases (more on Europe later).

Likewise, Asia is most vulnerable if LNG supplies from Qatar and the UAE are curtailed (Chart above). To be sure, China is benefiting from natural gas supplies via Russian pipelines. Nevertheless, nearly 30% of the region’s LNG is supplied through the Gulf.

Recently, the IEA announced a historically-large release of strategic oil reserves is unlikely to impact prices much (Chart above). First of all, the additional 400 million barrels will only replace supplies through the Strait for 20 days. Moreover, in practice, the inventory release is likely to be limited to only 5 million barrels per day — only 25% of the 20mbd transported daily through the Gulf prior to the war. Most developed nations and China hold oil inventories covering 3 to 6 months worth of consumption. Therefore, if the war is prolonged, oil prices could rise considerably further. Meanwhile, even less can be done to replace the lost LNG supplies.

Europe: Diversification Reduces Dependency

To be sure, Europe’s poor endowment of fossil fuel leaves the area vulnerable to price and supply shocks. However, the region has successfully diversified its sources of energy imports since the beginning of the Ukraine war. For instance, Europe no longer imports any oil from Russia compared to 25% of the total in 2021 (although the 15% coming from CIS countries may well be Russian). And, the Middle East accounts for only 15% of total EU petroleum imports. Meanwhile, the USA and Africa now supply over 50% of Europe’s oil imports (Chart above).

Natural gas experienced the same successful diversification. Russia’s share of EU NG imports via pipeline have declined from 50% to 10% since 2021 (Chart above). Norway, the UK, Algeria, and Azerbaijan now supply nearly 90% of these purchases. Similarly for LNG, Qatar only accounts for 10% of EU foreign purchases; whereas the USA (especially) and Algeria are responsible for nearly 60%. Russia’s share has declined from 20% to 14% since the Russian invasion.

However, as EU natural gas inventories are currently at very low levels, the region would be vulnerable to a prolonged price spike (Chart above).

Macropolicy and Strategy Considerations

• Following the Russian invasion of Ukraine, many European (and other) countries attempted to cushion the impact on local households by providing energy subsidies. However, with public sector debt soaring, governments will have fewer options to shield consumers from additional politically-sensitive cost-of-living pressures.
• At the beginning of the year, markets expected central banks to ease monetary conditions. However, with inflation rising, interest rate cuts are likely to be postponed until H2 2026 or later.
• I am hopeful the Iran war will be short-lived. Even so, however, oil and natural gas prices are unlikely to fall to pre-war levels, as energy inventories are restocked. On the other hand, oil prices could rise to unprecedented levels if the conflict last 3 months or more.
• So far, the economic consequences are manageable. However, 2026 GDP and EPS are likely to be cut in coming quarters. Asia is most vulnerable followed by Europe. The USA and other energy exporters are less vulnerable. Markets are already beginning to reflect these relative risks (next Chart).
• A short war would probably leave the Islamic revolution in place. This would raise the risk of future conflicts unless negotiations curb Iran’s nuclear and ballistic missile ambitions. Therefore, geopolitical risks deserve a higher market risk premium. In addition, with interest rate cuts delayed and earning growth disappointing, I continue to expect modest equity market returns in 2026, as originally outlined in my blog “Are You Feeling Liberated Yet?” (found in the website’s archive).