Two scenarios for the impact of the Middle East conflict on the global economy

The Middle East conflict currently has a negligible impact on the world economy, but if it escalates, oil supply and GDP will be seriously affected, according to JPMorgan.

On October 13, Jamie Dimon - CEO of America's largest bank JPMorgan Chase - issued a warning to investors: "Currently may be the most dangerous period the world has faced in the past few decades." He said that the fighting in Ukraine, Israel and Gaza could have a far greater impact on global energy, food, trade and geopolitical markets.

JPMorgan a few days ago released an assessment of the crisis in the Middle East. They said that "the conflict between Israel and Hamas forces has shocked the world". Therefore, this bank has researched the possibility of escalation and the accompanying impact of this event on the world economy as well as financial markets.

JPMorgan divides into two scenarios: The conflict remains as it is and the conflict escalates.

The market seems to be leaning towards the first scenario . Neither side of the conflict is a major oil producer in the world. The conflict will therefore not have a major impact on oil production and supply.

Oil prices increased this week , when Brent rose to more than 90 USD and WTI to 87 USD. But compared to the end of last month, prices are still quite far behind.

Brent and WTI oil prices in 2023. Chart: JPMorgan

The oil market is currently quite balanced in terms of supply and demand. JPMorgan commented that this is different from the beginning of last year, when the war in Ukraine first broke out. At that time, oil supply was already lacking compared to demand. War news therefore further disrupted supply, pushing prices to record levels. Brent at that time was close to 140 USD a barrel.

JPMorgan said the situation means markets can handle it if the disruption is not too severe. For example, the US would tighten sanctions on Iranian oil if it found evidence that this country played a role in the conflict. Iran currently contributes 3% of global supply.

A study a few days ago by Bloomberg Economics said that in this case, oil prices could increase by 3-4 USD per barrel compared to the present. However, they also agree that the impact on the global economy will not be significant, especially if Saudi Arabia and the UAE increase supply to compensate for the shortfall from Iran.

With the scenario of escalating conflict , JPMorgan believes that this possibility is currently unclear. However, "increased conflict will increase risks". Some compared it to 1973, when Arab countries banned oil sales to countries that supported Israel. This ban caused oil prices to increase by more than 300%, causing severe inflation and economic recession. Stock markets were also sold off for a long time.

However, there is currently no evidence that a similar scenario can repeat. Relations between Israel and Arab countries have improved. Global supply is also not concentrated in a few countries like before.

However, the conflict could escalate if Iran is officially dragged into it. This scenario will disrupt important shipping routes, such as the Strait of Hormuz - where about 20% of oil circulates for global consumption.

According to research by Bloomberg Economics, in the event of an escalation of conflict, oil prices could rise to 150 USD per barrel and global growth would fall to only 1.7%. This means 1,000 billion USD will evaporate from world GDP.

A petrochemical plant in Khuzestan province (Iran). Photo: Reuters

At that time, other oil producing countries will find ways to intervene. The US has recently accelerated oil supply. This is not enough to keep prices stable, but it can alleviate it somewhat.

JPMorgan believes that in the long term, geopolitical events typically do not have a lasting impact on markets. Michael Cembalest - Director of Investment and Market Strategy at JP Morgan Asset & Wealth Management has researched many post-war geopolitical events. In most cases, the impact on the market is short-term.

A graph of the performance of the S&P 500 index in the 12 months before and 2 years after each event from 1950 to 2022 shows that on average, the index did not change much.

However, JPMorgan also believes that past developments cannot 100% guarantee current results. Therefore, they advise investors to always diversify their portfolios. This will help investors benefit when the fluctuations end.

When instability increases, the US bank also believes that investors should focus on fundamental factors. For example, in the US, despite high inflation and interest rates, the labor and consumer markets are strong. Business investment and public spending remained stable. Therefore, JPMorgan believes that the possibility of a soft landing (cooling inflation and no recession) in the US is increasing and investing in stocks will have many opportunities.