With the U.S. and Israel beginning an aerial bombardment of Iran over the weekend, Investors have a new concern to worry about.  Markets had already been quite volatile to start 2026 as investors are confronting stubborn inflation, a weakening labor market and now a rethinking of how artificial intelligence will impact different economic sectors.  The uncertainty around this new conflict in the Middle East will surely have some investors pulling in their horns.

A New Conflict in the Middle East

It is, of course, impossible to know how long this conflict will last or what course it will take.  From the perspective of the global economy, it could be quite impactful, as roughly 20% of the world’s oil production flows through the Strait of Hormuz.  If the Iranians were to make the Strait impassible for tankers for a considerable amount of time, oil prices would likely continue to rise, pushing up prices at gas pumps around the world and leading to lower economic activity and perhaps higher inflation. China and India, in particular, are highly dependent on oil transiting the Strait.  Both countries get more than 40% of their oil through the Strait, so with that waterway effectively closed now, the economic impacts of not just less oil but also higher priced oil will begin to reverberate quickly through the Chinese and Indian economies.

Here in the U.S., higher for longer oil prices will put upward pressure on all prices, thus reducing the likelihood of interest rate cuts.  They will raise transportation costs for both individuals and businesses, thus dampening expenditures that could be made elsewhere.  While headlines about the fighting could be dramatic, we think investors will mostly care about the economic impact, and that impact will be transmitted most directly through oil prices. As I write this, Brent Crude is trading at $76.76, up about $5 per barrel since before the war began, but down from the $81 level it reached early this morning.  How soon the Strait opens again to normal traffic is very important to overall market sentiment.

Unfortunately for the Iranian people, it seems unlikely that a U.S./Israeli bombing campaign alone will be enough to help to get them out from under what has been a ghastly regime for nearly fifty years.  During last month’s protests, the regime killed tens of thousands of its own people.  While many Iranians want change, they simply do not have anything with which to fight.  Hard power in Iran rests with the Islamic Revolutionary Guard Corps (IRGC), and even though American and Israeli bombs are degrading the IRGC infrastructure by the day, it seems improbable that the regime can be driven out of power with just an air war.  Sadly, for the long-suffering Iranians, once this conflict is over there will probably just be new people at the top to oppress them.

In Other News, A New Fed Chair

Domestic matters will likely take a back seat to news about the war for the next few weeks, but we will have someone new in the top job at the Fed this spring.  Kevin Warsh, the administration’s nominee to be the next Chairman of the Federal Reserve, is seen by many as a traditional pick. He will take over from Jerome Powell in May.  Mr. Warsh, who was on the Federal Reserve Board of Governors during the 2008-2009 global financial crisis, has been known to be an inflation hawk and someone who is interested in reducing the size of the Fed’s balance sheet (which now totals about $6.6 trillion).  Lately Mr. Warsh has been less hawkish on inflation and instead offering a view that artificial intelligence will be a deflationary force in the economy and therefore provide the Fed room to lower interest rates from their current target of 3.5%-3.75% without fear of stoking additional inflation.  With inflation still sticky (the latest Producer Price Index came in hot at 0.8% versus an expected gain of 0.3%), Mr. Warsh will likely have a tough time convincing the other members of the Federal Open Market Committee to lower rates from today’s levels without some evidence showing that inflation is continuing down toward the Fed’s 2% target.  He will also likely face plenty of political pressure to reduce rates once he begins his new job.

As always, we welcome your comments and feedback.  Please contact us know if there is anything you would like to discuss about your investments or the markets.