The Middle East powder keg may finally explode

The Houthi leadership in Yemen faced a retaliatory strike by the US and the UK, targeting at least a dozen Houthi sites, including air defences, arms depots, and logistics centers. This response was triggered by the Houthi provocations in the Red Sea, notably a recent incident in the Gulf of Aden. The situation unfolds amid rising tensions in the region, part of broader conflicts involving Iran and its allies.

While this event may not constitute the "big one" — a direct threat to Iranian leaders or assets — circumstances could evolve if the current escalation jeopardizes Iran's credibility or an increasingly confident Israel expands its targets.

Concerns about the risk of miscalculation are growing, as rational actors may unintentionally become entangled in an escalatory spiral. Given the inherent complexity of Middle East conflicts, achieving a stable outcome in the region appears challenging, signalling the potential for continued instability with broad global repercussions.

Examining the potential implications of an escalation in growth and markets, the most significant impacts are expected to stem from energy supply disruptions. Oil prices could rise by 5% from current levels, while natural gas prices may surge by as much as 125%. In a "severe supply downside" scenario, where maritime traffic in the Strait of Hormuz is disrupted, oil prices might spike by over 20%, and natural gas prices could soar by up to 370%.

The EUR might incur the greatest losses considering the potential impact on FX.

Even a $10/bbl increase in oil prices could have moderate inflationary effects, potentially influencing the Fed. Investors are cautioned not to underestimate the potential impacts of the conflict on global risk assets and oil-dependent economies, where even the current low probability of a broader conflict warrants some risk premium, currently not fully priced into the markets.

Looking at the broader fate of Gulf oil exporters, including the UAE, Qatar, and Saudi Arabia — recognized as economic powerhouses — these nations are expected to remain central to power and influence in the Middle East. They are viewed as formidable geopolitical forces in an increasingly complex global landscape, given their status as "geopolitical swing states."

In terms of risk mitigation, allocations to safe havens, assets that may benefit from an escalating geological shock, and option hedges are suitable for various scenarios. Current strategies may involve long positions in USD and CHF, allocations to commodities, or the addition of equity puts following a significant decline in volatility observed last month. Or simply cash in, king, while parking your funds in a 5 % money market garage.