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Investment insights from Capital Group

The United States’ decision to attack Iran over the weekend, dropping powerful bombs on Iranian nuclear facilities and other targets, has significantly raised the already high geopolitical risks that have disrupted the global economy and financial markets this year. While it’s difficult to know what comes next, there are three key areas of risk for investors to monitor in the days ahead.

1. Geopolitical volatility

Heightened risks of miscalculation between the U.S., Israel, Iran and regional proxies, combined with potential Russian or Chinese interference, are creating a more fragmented and unpredictable geopolitical landscape.

Much depends on Iran’s response in the coming days and the subsequent decisions by U.S. leaders to raise or lower the level of American involvement. Will Saturday’s bombing mark the height of U.S. intervention or is this just the beginning of a wider and more complex conflict in the Middle East? The world will be watching closely.

2. Energy market risk

The threat of retaliation from Iran is looming, including possible strikes on U.S. military bases and attempts to disrupt oil shipments moving through the Strait of Hormuz, a choke point for nearly 25% of global oil supply.

Even before the U.S. bombing raid, Brent oil had spiked above $76 a barrel over the past few days on the back of the Israel-Iran conflict. Severe escalation threatens to push oil prices potentially much higher.

However, looking back at history, energy markets have generally bounced back quickly from geopolitical shocks, with only a few events causing lasting increases in oil prices. Since 1967, none of the major military conflicts involving Israel have had a continuing effect on oil prices except for the Arab-Israel War in 1973, which led to an oil embargo by the Organization of Petroleum Exporting Countries (OPEC). This was especially impactful because OPEC controlled over half the global oil supply at the time.

The global oil market is better equipped to absorb supply shocks now, thanks in part to rising U.S. shale production and advances in energy efficiency. OPEC’s share of global oil supply has declined from over 50% in the 1970s to below 40% today.

Given that the direction of oil prices will depend greatly on what happens next, we have outlined four scenarios and the possible impact on oil prices. The key determinants are the level of U.S. involvement in the war going forward and the ultimate scale of the conflict.

3. Financial market impact

Investor behavior has shifted. Gold has rallied, defense and energy stocks have posted gains, and volatility indicators such as the VIX are at elevated levels and likely to remain there until we receive greater clarity on whether the war with Iran escalates or peace negotiations resume.

What to watch as events unfold

Proxy skirmishes: Potential disruptions from Iran-backed militias targeting infrastructure in Basra.

Direct strikes on Iranian energy assets: With Iranian production currently at a five-year high, any significant disruption could trigger a sharp price spike.

Iranian interference in Gulf energy routes: Around 25% of all seaborne oil flows through the Strait of Hormuz. While a full closure of the Strait is unlikely due to strong U.S. naval presence, even limited interference could pose a serious risk to oil prices.