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Stocks and bonds were lower on Tuesday as fears of a prolonged shock to energy prices from the conflict in the Middle East rattled global markets and Iraq was forced to start shutting down oil production.
European stock markets fell more than 3 per cent in the steepest one-day drop since US President Donald Trump launched his trade war last April, while US markets were nearly 1 per cent lower in afternoon trading in New York.
The sell-off spread to government bonds as traders bet that soaring energy prices, caused by Iran’s success in disrupting the region’s oil and gas supplies, would force central banks to refocus on inflation rather than cutting interest rates. Stocks and bonds retraced some of their earlier losses by mid-afternoon.
“Inflation is not dead, we haven’t killed that animal,” said Andrew Jackson, head of investments at asset manager Vontobel, adding that surging oil and gas prices “are going to make it worse”.
Iran has threatened to attack any tanker attempting to pass through the Strait of Hormuz, the narrow waterway at the entrance to the Gulf through which a fifth of the world’s oil and a quarter of its liquefied natural gas normally passes.
On Tuesday, Iraq said it was shutting down its largest oilfields because of the lack of tankers willing to risk the journey, helping to push oil briefly to a 19-month high above $85 a barrel.
It was trading back at $80 later in the day after Trump said the US Navy was prepared to escort tankers through the Gulf and that the US would offer insurance for vessels transiting the region.
European natural gas prices also rose, almost doubling this week, after QatarEnergy, the world’s largest LNG producer, halted production. Asian gas markets, which are heavily reliant on shipments of LNG, jumped 65 per cent on Tuesday.
The moves came as strikes escalated across the region in the fourth day of the conflict. The US closed its embassies in Saudi Arabia, Kuwait and Beirut, as the state department told Americans to leave the Middle East.
The Israeli air force said it had begun a new wave of “extensive” air strikes against the “infrastructure” of the Iranian government in Tehran, while Iran struck the US embassy in Riyadh with two drones.
Iran also stepped up its strikes on energy infrastructure in the Gulf in retaliation for the US-Israeli assault, which began on Saturday.
“The market seems to be mentally transitioning from a short war to a long war,” said Peter Schaffrik, global macro strategist at RBC Capital Markets.
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German Chancellor Friedrich Merz warned on Tuesday of the economic damage caused by higher oil and gas prices, adding that he hoped the US-Israel military campaign against Iran would end “as soon as possible”.
Traders have started to price in a 25 per cent chance of a rate rise by the European Central Bank before the end of the year, according to levels implied by swaps markets, while in the UK traders now only expect one quarter-point cut this year.
Trump has shown little sign of seeking an end to the conflict, however, even as he said the mission had already “knocked out” Iran’s navy, air force and air detection radar.
The US president threatened to escalate a trade war with Spain after the country’s Prime Minister Pedro Sánchez criticised his decision to go to war.
“Spain has been terrible,” Trump said. “We’re going to cut off all trade with Spain.”
The price of gold, which rose on Monday as investors sought shelter from the uncertainty, fell 3.9 per cent alongside the drops in stocks and bonds on Tuesday, with analysts suggesting that traders could be liquidating other positions to cover their losses.
“It’s panic selling,” said Emmanuel Cau, head of European equities strategy at Barclays. “This is a stagflationary scare. The market was complacent about the scale of this war.”
