Oil Spikes Regardless of Measures to Ease Pressure

Geopolitical Risks Trump Policy Tweaks

As we approach the end of the second week following the joint US-Israel operation in Iran, which inflicted substantial damage on oil infrastructure and disrupted traffic through the Strait of Hormuz, a critical chokepoint for approximately 20% of global oil flows, the market's response has been volatile. Proposed measures to alleviate upward pressure on prices appear to be having little effect.

These actions included a pledge from International Energy Agency member nations to release a record volume of oil from strategic reserves. The US also declared it would provide insurance and naval escorts for vessels navigating the Strait of Hormuz. Further, Washington temporarily waived the Jones Act, a century-old law requiring goods transported between US ports to be carried on American-built ships, thus permitting foreign flagged vessels to participate. More surprisingly, the US signaled a willingness to permit India to continue purchasing Russian oil to mitigate global price pressures, and hinted at wider latitude regarding Russian oil exports. Despite these interventions, upward pressure persists, fueled by regional instability, damage to key oil facilities, and the potential mining of the Strait of Hormuz by Iran.

WTI crude briefly surged to $98 per barrel before retreating slightly this morning. Brent Crude reached $100 per barrel and is currently consolidating around $98. The market's resilience suggests that short-term solutions are insufficient to address the underlying geopolitical risks. A continued escalation could worsen the situation considerably.

Inflationary Winds Picking Up Speed

Rising oil prices have intensified concerns about global inflation throughout the month. Gasoline prices in the US have jumped over 25% since the start of the month and nearly 80% year-to-date. Energy costs, however, are only one piece of the puzzle. Trade policy also plays a significant role.

Recent reports indicate that US trade officials are exploring avenues to reinstate tariffs previously deemed unlawful by the Supreme Court. The combination of elevated energy expenses and renewed tariffs would likely be passed on to consumers, further darkening the inflation outlook for both the US and the global economy. Given the US's influence on global markets, these developments carry substantial weight.

Yield Curve Signals Growing Anxiety

Investors, while becoming accustomed to war headlines, remain sensitive to rising energy costs. The US 2-year Treasury yield, a key indicator of Federal Reserve policy expectations, climbed past 3.75% as higher energy prices diminished hopes for rate cuts. Activity in Fed funds futures reflects this shift, with markets no longer fully pricing in a 25bp rate cut this year. Some investors now believe the Fed may refrain from cutting rates altogether in 2026, despite calls for immediate easing. However, an unmerited rate cut would not necessarily lower yields.

The short end of the yield curve is being driven higher by expectations that the Fed may hold steady, while the long end is pressured by concerns that a protracted conflict could further strain US finances. The US 10-year yield is nearing a test of the 4.30% level, and the 30-year yield is topping 4.90%. Rising yields and private-equity stress are weighing on equities. Signs of trouble are emerging in the private-credit space, with banks facing increased redemption requests due to a software selloff. Risk appetite in the SaaS sector remains weak despite valuation declines.

Adobe's earnings, released after yesterday's close, exceeded expectations for both revenue and earnings, yet the stock still declined 6-7% in after-hours trading. AI-related concerns, coupled with the announcement of the CEO's departure, contributed to the decline. Big Tech stocks also slipped, despite positive earnings from Oracle. The S&P 500 fell 1.52% yesterday. Despite these headwinds, the index remains less than 5% below its January peak, suggesting a relatively contained correction.

US and European futures are indicating modest gains this morning; however, a sustained recovery seems unlikely until Middle East tensions de-escalate. Today, investors will focus on US GDP and core PCE updates. The Core PCE Price Index is the Fed's preferred inflation gauge. US growth is projected to slow from 4.4% to 1.4% in Q4 due to cooling consumer spending, high borrowing costs, normalizing inventories, waning AI investment, and trade pressures. Core PCE is expected to rise to approximately 3.1%, remaining above the Fed's 2% target. This data comes before the recent surge in oil and gas prices. The market reaction to today's data could be asymmetric, with inflation figures taking precedence over growth data. A strong PCE print could further dampen rate-cut hopes, while a weaker reading may do little to alleviate concerns about future inflation.

Looking ahead, uncertainty, market volatility, and the risk of slower global growth combined with rising inflation are likely to persist. Markets will eventually stabilize, but further downside may be ahead.

Portfolio Impact: Navigating the Energy Shock

The ongoing surge in oil prices driven by geopolitical instability presents both challenges and opportunities for investors. The immediate impact is inflationary, potentially delaying or reducing the magnitude of anticipated interest rate cuts by central banks globally. This scenario favors a defensive portfolio positioning, emphasizing sectors less sensitive to economic cycles.

Assets to watch closely include:

• Energy Stocks: Companies involved in oil and gas exploration, production, and refining stand to benefit from higher prices, although geopolitical risks introduce volatility.
• Inflation-Protected Securities: Treasury Inflation-Protected Securities (TIPS) and similar instruments offer a hedge against rising inflation, preserving capital in real terms.
• USD/CAD: The Canadian dollar, being a commodity currency, typically strengthens alongside oil prices. However, broader risk sentiment and the Bank of Canada's policy stance will also play a role.
• Gold: As a traditional safe-haven asset, gold tends to perform well during periods of geopolitical uncertainty and inflationary pressures.

  Traders should monitor key technical levels in WTI and Brent Crude, as well as the US 10-year Treasury yield. A break above $100 in Brent could signal further upside, while a sustained rise in the 10-year yield above 4.30% may indicate increased pressure on risk assets. The primary risk lies in a potential escalation of the Middle East conflict, which could trigger a sharp correction across asset classes. Conversely, a de-escalation could lead to a rapid unwinding of energy-related positions.