As I typed this post yesterday (Monday) morning the stock market was set to open up a bit, which was surprising given news over the weekend of the US jumping into the most recent Middle East conflict with both feet.
As you’re no doubt aware, this past weekend we hit three of Iran’s nuclear facilities with 14 Massive Ordinance Penetrator bombs, or “bunker busters”. How much of an impact the strikes had on Iran’s nuclear program and what Iran’s response will be isn’t clear yet. Iran suggested it might block the Strait of Hormuz, but they hedged the statement with no major development since. The Strait sees 20% of the world’s petroleum consumption passing through daily, according to the US Energy Information Administration. Oil prices opened down about half a percent yesterday, a subdued response nearly as surprising as the ho-hum response of the stock market.
Again, this is an evolving situation that at least for the time being is having a muted market impact. Fast forward to the market close yesterday and major stock indexes had risen nearly 1%, even after news of Iranian escalation at midday. Read to the end and it’s no wonder why the market is so far brushing off the conflict.
I don’t want to get too far out of my lane in these posts, but here are a few paragraphs from an update I received yesterday morning from my research partners at Bespoke Investment Group. Bespoke does a lot really well and one of those things is providing objective context. Maybe this helps answer some of your questions, especially given the rise of near-apocalyptic stuff surfacing online.
From Bespoke…
It remains unclear how much effect the [US bombing] attack had. First, the International Atomic Energy Agency (IAEA) Director General said late last week that the ~400kg of highly enriched uranium (HEU) that was stored underground at the Isfahan facility hasn’t been seen by inspectors since a week before Israel launched its attacks. 400kg of HEU could be moved around in less than a dozen small sedans if necessary, so it’s entirely possible it was removed and dispersed early in the war; it also may still be sitting at Natanz and not have been damaged. There have been no major radiation signatures from the US or Israeli strikes on Iranian nuclear facilities, so that stockpile is unlikely to have been destroyed. Beyond that, the material damage to Iranian facilities is unclear at this point, especially given DoD damage assessments are incomplete. It’s possible that the strikes dealt a massive blow to Iran’s ability to enrich uranium and build a fission device, and it’s possible that the raid was all light and no heat. Only time will tell.
For the markets and global economy, the key question now is how Iran will respond. As-of this writing 36 hours after the strike, there had been no military response against US assets […] Iran’s military performance in response to Israel’s attacks has been abysmal, with very limited abilities to beat Israeli defenses using ballistic missiles and drones as well as abject failure at controlling its own airspace. While hitting back at US bases in the Persian Gulf would be much easier than striking Israel given the distances involved, the actual ability to do so from Iran is unclear. Similarly, it should be relatively easy for Iran to make the Strait of Hormuz basically impassable for civilian traffic, but given how badly they have failed to live up to expectations in other areas it wouldn’t be a surprise to learn they cannot. In addition to conventional military responses like strikes against US bases or closing Hormuz, unconventional responses are of course a possibility but not a likely one. Those would include stochastic attacks inside the US or the use of a “dirty bomb” (conventional explosives combined with enriched uranium or related byproducts to use radiation as a weapon rather than fission) against the US or Israel. Finally, it’s possible Iran is now in a “sprint” to a true nuclear weapon for use in response; this is also possible but would take at least a time of months if not longer to achieve based on their known capabilities.
In terms of likelihood, we view the stochastic attack/dirty bomb unconventional response as the least likely by far. While that approach is possible we don’t see it as easy to achieve or likely to stop attacks in Iran (if anything, the opposite) and therefore is very unlikely. Similarly, while achieving a fission bomb is certainly possible, doing so under a barrage from the sky would be very difficult; this outcome is more likely than the prior set but is still very unlikely by any measure. More conventional responses including closing Hormuz remain a possibility, but that would also impact Iran’s ability to export oil. On Sunday, Iran’s parliament reportedly endorsed a plan to close that vital oil supply line, but with the caveat that any decision to do so rests with Iran’s Supreme National Security Council.
[…] Global oil markets are of course fungible, but by far the largest destination for these [petroleum] flows is China. In other words, closing Hormuz would have the most direct negative impact on one of two countries most likely to back Iran in a war against the US and Israel. Both China and Iran’s other major power relationship (Russia) have condemned the attacks but otherwise stayed out of the war and we see little reason for that to change near-term. While there are risks of Iran lashing out globally in response to this war, a broader conflagration is not one.
Given Iran’s relatively weak capacity compared to expectations since the original strikes by Israel, we see a massive response against US bases or the Strait of Hormuz as less likely than not at this stage. It remains an open question whether Iran can execute that kind of response at all. We also see an American invasion of Iran as extremely unlikely by any measure. Polling is clear on this issue: bombing Iran is not popular (-19 net approval per YouGov) and a June 16 poll by that same outlet found a -44 margin for the idea of getting involved in the war at all. While opinion polling is not an inevitable driver of what happens next, the President’s coalition contains a range of non-interventionists and it’s a generally unpopular policy, both worth keeping in mind when mulling what happens next. In short, the odds of this conflict fizzling out are much higher than might meet the eye, even if there are a range of lower-probability risks that have much more negative outcomes.
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