Markets are betting on lasting peace in the Middle East. Codogno's analysis

On the same topic:

“The US attack on Iran has brought the Middle East conflict to new levels of uncertainty and risk, but there are also potentially positive developments. Therefore, financial market reactions may not be overly adverse.” Lorenzo Codogno, economist at the London School of Economics and founder of LC Macro Advisors, had predicted this in his newsletter on Sunday evening, at the end of a fiery weekend, and so it was. On Monday morning, the reaction of European stock markets to the military escalation was all in all contained, also in the wake of futures movements that announced a substantially flat opening on Wall Street. Half an hour before the close, the indices of the old continent were all losing less than 1 percent (Piazza Affari minus 1.2 percent).

In practice, it is as if Donald Trump could do more damage with tariffs than with the war in Iran. Indeed, Codogno tells Il Foglio: “If in the end Trump were to achieve a stabilization of the Middle Eastern area, even with the use of force and outside of a framework of international rules, investors would see it as a positive turning point”. Some key factors remain to be monitored, warns the economist, “to understand whether in the long term the situation could evolve in a way that causes substantial damage to the global economy and financial markets, in parallel with the growth of uncertainty and the perception of insecurity”. What are these factors? The first is the risk of a nuclear conflict. How concrete is it? The premise is that it is not easy to distinguish between propaganda and reality, to understand whether Iran really has nuclear weapons. However, the fact that Tehran’s uranium enrichment has reached a level of 60 percent (while civilian use is typically around 3.5 percent) was confirmed by the IAEA, which clearly indicated that the country was seeking to develop nuclear military capabilities. “It is as if the markets were willing to tolerate possible short-term turbulence in order to achieve greater long-term stability after decades of geopolitical tensions generated mainly by the nuclear threat.” This is investors’ realpolitik: even if it was not right to attack Iran while open negotiations were underway in Oman and with the EU, the goal of sustainable peace could become more achievable. Will it last? “This will be the first key element to evaluate in the coming days,” Codogno summarizes.

The second factor to focus on, for the economist, is the degree of damage to Iran's military sites. If evidence emerges that the country's capabilities have been severely compromised, it would be more difficult for Iran to provoke the "eternal consequences" that the world is so concerned about. The third factor to monitor is whether there will be internal division in the United States. Support for Trump is not in doubt at this very delicate stage, "but if the conflict were to evolve into a prolonged war, that support could weaken." And there is a fourth factor: Is the Iranian regime on the verge of collapse? A militarily and economically weakened regime could pave the way for peaceful democratic progress. On this level, it is to be understood whether a regime change, driven by internal pressures, drastically altering the political balance in the Middle East, could lead to lasting peace. In the meantime, however, Iran's response could involve the blockade of the Strait of Hormuz , along with new Houthi attacks that would further hinder the passage of the Suez Canal. "The global supply chain and the supply of oil and liquefied gas would be compromised, resulting in higher energy prices. Energy supplies to China would also be significantly affected." This would have a significant effect on the global economy (oil forecasts above $100 are already circulating). "However, it is important to note that this scenario would also damage Iran's economy and limit its ability to sustain a prolonged conflict. The fifth factor is the type and strength of Iran's response." Other possible developments to monitor are the role of Russia and China. While the involvement of the latter can be ruled out for the moment, that of the former is an unknown. “Personally, I think that only an international order based on shared rules can guarantee sustainable peace,” concludes Codogno. “According to international law, the United States cannot aim for regime change in Iran, but if this were to happen, the removal of a terrorist regime could lead to more peaceful developments. It is this possible perspective that limits the negative effects on financial markets.”

More on these topics: