Despite worsening on-the-ground conditions in the Middle East, Emerging Markets have rallied. This is not due to a belief the conflict is solved, but that tail risks of a wider military escalation are contained. The market is pricing the absence of a worst-case scenario, with negotiations continuing through non-military leverage like blockades.

Despite the administration's mixed and often aggressive messaging, financial markets are betting on a swift end to the conflict. The significant drop in oil prices reflects a collective, unemotional assessment that the Straits of Hormuz will reopen soon, providing a powerful counter-signal to political statements.

Even if the Mideast conflict de-escalates and oil falls to $80, the outlook for equities remains negative. This price level is still too high to prompt Fed rate cuts, the global liquidity picture remains poor, and foreign capital repatriation will continue to weigh on markets.

A significant disconnect exists between asset classes. The oil futures curve prices a prolonged shock, with prices 40% higher by year-end. In contrast, equity and bond markets are largely flat, reflecting a complacent belief in a quick resolution and central bank easing, completely ignoring the underlying supply-demand math.

Markets are downplaying the Hormuz risk because investors have been repeatedly 'head-faked.' After selling the bottom on warnings about COVID, inflation, and bank failures, they are now conditioned to dismiss major threats, creating a dangerous vulnerability if this crisis proves different.

Financial markets are focused on the economic impact of conflict, not the conflict itself. For the Iran crisis, the key factor is the flow of oil and LNG. If the Strait of Hormuz were to reopen, markets would likely look past the ongoing fighting, treating it as a political issue rather than a market-moving event.

The expected wave of M&A and LBOs has not materialized, leaving the deal pipeline thin. This lack of new debt supply provides a strong supportive backdrop for credit spreads, allowing the market to absorb geopolitical volatility more easily than fundamentals would otherwise suggest.

While short-term oil contracts react to immediate geopolitical stress, a sustained rise in longer-dated prices above $80-$85 indicates the market believes the disruption is persistent, signaling a more severe, long-term economic impact.

Despite heightened U.S.-Iran tensions, oil prices show only a minor risk premium (~$2). The market believes an oversupplied global market, coupled with a U.S. preference for surgical strikes that avoid energy infrastructure, will prevent a major supply disruption.