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What happened?
The United States over the weekend conducted what President Donald Trump described as “very successful” airstrikes on three of Iran’s nuclear facilities: Fordow, Natanz, and Isfahan. Announcing the operation on Saturday evening, Trump confirmed that US B-2 bombers had dropped a full payload of specialized bunker-busting bombs on the primary target, Fordow.

US officials say the strikes caused “extremely severe damage and destruction” to Iran’s nuclear infrastructure, with commercial satellite imagery suggesting significant impact at the targeted sites. However, a Reuters report citing an unnamed senior Iranian source claims most of the highly enriched uranium at Fordow was moved to an undisclosed location prior to the strikes.

US diplomats are said to have informed Tehran the strikes are intended as a one-off limited action, according to CBS, with no plans to pursue regime change. But Trump also indicated the potential for further US involvement in the event of Iranian retaliation, saying “there will be either peace, or there will be tragedy for Iran far greater than we have witnessed over the last eight days.”

Iran’s foreign minister Abbas Araghchi warned the US strikes will have consequences and that Teheran “reserves all options to defend its sovereignty, interest, and people.” Iran's parliament on Sunday reportedly backed the idea of closing the Strait of Hormuz, a critical crude oil shipping choke-point. So far, there has been no sign of follow-through, though some larger tankers have reportedly altered course to avoid the area.

Israel and Iran exchanged a new wave of missiles attacks on Monday, with Israel reportedly resuming strikes within Iranian airspace. Iraq’s government via a statement condemned the targeting of the nuclear facilities and called for an “immediate de-escalation and the urgent opening of diplomatic channels to contain the situation and defuse the crisis.” Saudi Arabia also underscored the need to “de-escalate tensions, and avoid further escalation,” calling to “reach a political solution.” As a first reaction, Iran may withdraw from the nuclear Non-Proliferation Treaty of nuclear weapons, based on reporting from Reuters.

At the time of writing, Brent crude is trading fractionally higher at USD 77 a barrel, having been as high as USD 81.4 initially. Gold is flat at USD 3,367/oz. The US dollar index DXY is up 0.6% at 99.3, and S&P 500 futures are up 0.2%.

What do we expect?
The US strikes on Iran mark a significant escalation in the regional conflict.

In the days ahead there will be two key questions: First, will energy exports from the Middle East be interrupted, including oil shipments through the Strait of Hormuz? Second, will other major countries intervene?

Oil is the main conduit for the transmission of Middle East tensions to the global economy and broader financial markets, and in the very short term, oil prices are likely to rise as investors price the risk that the conflict escalates further and supplies are disrupted.

We think that retaliatory Iranian attacks on US bases, US allies, and energy infrastructure in the wider region are a clear risk. The amount of damage that Iran could cause remains unclear, though drones may play a bigger role if planned strikes are close to Iran’s borders. The war in Ukraine has shown how combining missile with drone attacks can over-saturate air defense systems, allowing them to target energy facilities in neighboring states. Threatening maritime traffic through the Strait of Hormuz, or mining this crucial choke-point, remain a possibility. In a risk case, Iranian attacks could damage or destroy key assets in the region. A 2019 attack on Saudi Arabia’s Abqaiq oil processing facility temporarily stopped nearly half of the kingdom’s oil production.

That said, Iranian military capabilities have already been damaged by the air campaign so far, and Iran’s military and navy will likely not be able to resist the combined power of the Israeli and US forces for a prolonged period. Restoring energy supplies—should they be disrupted—will be a major focus in the region following any potential attacks. We also note that historically, in the event of sustained and significant disruptions, OPEC(+) has increased production to keep the market in balance, and OECD countries may also tap into strategic oil reserves to cover temporary shortfalls in supply.

A second key concern is whether US involvement draws other countries into the conflict, with Russia a particular concern as it could see potentially long-lasting disruptions to oil markets as a way of strengthening its own hand in negotiations with the US over the future of Ukraine.

However, in our base case, we don’t think Russia will become involved in the conflict. Russia and Iran signed a “Comprehensive Strategic Partnership” earlier this year, and Russia condemned the Israeli attack on Iran. But while Russian President Vladimir Putin offered to help mediate in the conflict, he also explicitly pointed out that military aid was not covered under the strategic partnership. In addition, Russia’s military capabilities are stretched by the war in Ukraine, and appearing as an antagonist to Israel and the US may also risk triggering the US to reconsider tougher sanctions or increased support to Ukraine.

How do we invest?
Phase into equities. In our base case, we do not expect the escalation in the conflict to lead to a prolonged disruption to oil supplies in a way which could imperil global growth or cause significant challenges for central banks. So, we believe that near-term downside in stocks could represent an opportunity for investors who are underallocated to equities to build positions.

Sell dollar strength. The US dollar may rally in the very short term as investors seek safe havens amid geopolitical uncertainty. However, we think the fundamental trend of global investors diversifying long-held US dollar holdings in light of likely slower growth, lower rates, loose fiscal policy, and political uncertainty will continue, and we expect the trend of US dollar weakness to continue over the medium term. We believe investors should consider using near-term strength to diversify or hedge excess US dollar holdings.

Navigate political risks. We think gold remains an important portfolio hedge against rising geopolitical risks. While in our base case we target gold prices of USD 3,500/oz over the next 12 months, in a risk-off scenario, we believe that prices could rise as high as USD 3,800/oz. A weaker US dollar and lower real rates should also help support prices.