Oil Surges After Iran Conflict - What It Means for Inflation & Markets

Hello and welcome back to the Market Maker podcast, and it's been an incredibly busy week. So we're jumping on to record this on Thursday, the 5th of March. Before we begin, obviously, you know, what we're going to talk about here is a sensitive topic. We're definitely going to park politics and just talk about this from a finance perspective. And obviously our sympathy goes to anyone involved. In the current conflict that's happening in Iran. But in terms of this episode, what we're going to talk about then is get up to speed of what's been happening, but really try to step out of the individual headlines because there are many, and try to look at this from the bird's eye view of a macroeconomic perspective. And what I really want to get into conversation with you, Piers, is about what does this mean for the expectations for interest rates? The US economy, any divergence between what's happening in America and in Europe, because I think there's talk now of the ECB hiking rates, which gives me kind of mental scarring from what was it, 2011 or the sovereign crisis when they were hiking rates when everyone was cutting. So lots to chew over, but let me give you the headlines as it stands today. So the US-Israeli war on Iran, it's entered its now 6th day. With no sign of easing, the Islamic Republic has said its retaliation against American strikes would escalate. Israel is carrying out waves of airstrikes on Tehran, hitting military intelligence assets following attacks on Hezbollah militia in Lebanon. Brent has climbed above $84 a barrel at the time of recording. So that's after jumping 12% after the first 3 days of the week. Perhaps we could start with a little bit here of a geography lesson. I feel like, uh, I feel like you're like my dad or something. It's like every time we jump on the podcast, I either get physics lesson, a chemistry lesson. Today I feel like we're getting a geography lesson from you, Piers. So what have you got in the back pocket for this one?

An impromptu geography lesson. Well, it's It's called the Straits of Hormuz is the key strategic bottleneck is the, is, is the word. So this is the, so you've got the Persian Gulf. I'm not going to go into too much detail here, but you've got like Iran and Saudi and like Kuwait at the top of that. And it comes out through a little funnel and it's called the Straits of Hormuz. And then you've got the UAE and Oman and Qatar all in the mix. Coming out of this Persian Gulf. The thing is about the specific section called the Straits of Hormuz is where this Persian Gulf really narrows. And actually, I think at its narrowest, I had a stat, it's 33 kilometers wide at its absolute narrowest point. Now the thing is that it's such an incredibly busy shipping lane, as we're going to talk about in a sec, but basically Obviously you've got two-way traffic, right? And so there's, there's specific sections of the Straits of Hormuz. One's going one way, the other one's going the other way. And so you need two shipping lanes in a 33-kilometer sort of kind of strip. And this is where it all gets crammed into this tiny point. So the other point to make is, given some of those countries I mentioned, Saudi Arabia, Iran, Kuwait, UAE, Qatar. Yes, they're all Gulf nations, but they also happen to be huge monster, massive energy producers, oil and gas. And the, the kind of access to global demand for this supply, the access is shipping most of it out of the Persian Gulf, out through the Straits of Hormuz. And so any kind of conflict scenario that disrupts disrupts the kind of shipping lane and therefore disrupts this, at least the seaborne supply of this stuff, well then is a huge strategic issue and leads to prices spiking higher, obviously. So this is just straight up old-fashioned classic supply risk leading to prices rising.

Yeah, it's, I think it's quite incredible to think that you've got what, a fifth of the world's global oil going through that one choke point. Point, and yet it's single-lane traffic. Yeah. It's quite an incredible thought to visualize actually when you put it that way.

Well, that's it. And it's kind of, you've mentioned the one-fifth there, so maybe we can just kind of talk about, I mean, there's two sides to this from an energy kind of supply perspective is crude oil and it's natural gas. If we talk about like crude oil, for example, And as you say, it's about 20% of global supply that kind of flows through that Strait of Hormuz. The thing is about that, weirdly, that hasn't really changed the proportion of global supply. I was doing a bit of research on this. I thought I was expecting that the proportion of global supply getting shipped through that would've changed over the years. 'Cause what's happened, particularly in the last sort of 15 years, the biggest, biggest impact that's happened on global oil supply is that the US has gone from being a producer of about 4.5 million barrels of oil per day to now the largest producer in the world at 13 million barrels of oil per day. This is the shale oil revolution, right? And I was thinking, well, if the US kind of production rates have spiked like that, then surely less proportion of global oil gets shipped out of the Straits of Hormuz. Therefore it's less, it's less of a strategic thing, it's less of a supply risk. But actually it's not true. And because it's kind of, whilst yes, the US have been producing more oil, the Gulf nations have not. And in some cases the amount they're producing is slightly lower, but the demand curve is still rising. And so actually, whilst, you know, the big change about the dependency on Gulf energy, the big change has shifted geographically. So actually it used to be, if you go back to the '70s and the 1980s and the '90s, then actually it was the West, it was Europe and the US that were very dependent on oil coming out of those Gulf nations. Actually now the US is oil independent. Pretty much, or at least kind of in, within their own continent, adding on top of their own with, with some, a bit of Canadian and a bit of Mexican and whatever. Right. But so they don't need really kind of Middle Eastern oil anymore. So actually it's now the East. So you've got the likes of China and India and Japan, for example, that are now the ones that are very reliant on seaborne oil supplies getting shipped out of the Straits of Hormuz. So Overall, it's still roughly 20% of global supply. It's about 35% of seaborne oil. Obviously oil gets transported either by ship or by pipe. So the seaborne stuff is about 35%, but yeah, it's Asia that are in the immediate crosshairs here from, you know, this sudden jump in price.

Yeah. I mean, connecting the dots then. Geopolitically, it wasn't only several months ago, you, you know, you get those shots of Xi Jinping and with India and so forth. So I'm assuming then that the large majority of that coming out of the Straits of Hormuz is servicing places like India and China. So longer term then, this more move to isolation, if you like, self-independency in America. I can see how this does fuel that bigger, longer-term shift of the rebalancing of powers out of that center of what has been the contested area of the supply of crude out of the Middle East.

Yeah. And maybe, I mean, look, you might go, oh, well then isn't this why Trump's being a little more kind of a little sort of more aggressive, you might say, in terms of his his actions in the Middle East because, well, the US are less dependent on energy from there. So the risk for them, you know, from this supply side isn't there. But actually that's too simplistic a comment because the thing is global energy prices are highly correlated. So whilst yes, it is true that Brent crude oil, and perhaps here we should just introduce the fact that there are, you know, in this world, there are two main grades of crude oil. It's called Brent, and then the other one's called WTI, West Texas Instrument. Okay. Now Brent crude is the stuff that gets pulled out at the kind of in the Gulf nations. Okay. And so Brent crude, prices of Brent has spiked aggressively here. And actually, maybe let's just have a quick look at the chart because from a Brent crude oil point of view, if you go back to, you know, let's go back to the, well, let's go back to last weekend before all this kind of really started to kick off. We were below $70 a barrel. Okay. And you know, and oil had been in quite a nice little tight range, you know, relatively speaking, a nice little tight range for a while and actually trending lower. We had big problems back in 2022. This was actually off the back of another, well, the last kind of geopolitical supply impacting scenario, which was Russia invading Ukraine. And back then in 2022, Brent prices almost, well, they hit $120 almost at one point. But really ever since the end of 2022, prices have been trending lower down to $60, which was the low around about Christmas time. Okay. And actually that $60 print for Brent was actually the lowest price we'd seen since 2021. And it was only that low through the COVID period where the demand side kind of collapsed. But look, we hit $60 downward trending market. This is all great because don't forget, from an economic perspective, energy is obviously such a key kind of component of our day-to-day lives from an individual's point of view, filling up their car with petrol through to You know, companies and industry and governments, right? Everyone needs energy. And so energy's such a critical part of our system and our economy. And so when the prices of energy really start to swing about wildly, it's a problem. But when energy's cheap, well, that's a real economic boost, right? Unless you are a major producer and you are highly reliant on revenues coming from that energy you are producing. Like all of the Gulf regions, right? But most countries aren't major oil producers. And so therefore, net-net on the global economy, if oil prices are cheap, it's a positive thing from a kind of global growth story, right? So trending lower down to $60, 5-year lows, you know, positive stuff. And all of a sudden it's kind of flipped now. So having hit $60 around Christmas time, we were trading just below $70 pre this scenario that's kicked off in Iran, and now we're up at $83 and climbing. So actually this is, I think we're 5 days up in a row now. This is the highest levels we've seen for Brent for 18 months. And so yeah, you've got, it's the speed of increase here that's obviously very notable. But I was talking about Brent and then WTI, right? So Brent's the stuff that comes outta the Middle East. It comes outta the Northern Sea here in the UK, for example. So all the stuff that Asia are buying is Brent. WTI, this is pulled out of the Gulf of Mexico, do I call it, or the Gulf of America if you're Donald Trump. That stuff is lighter and sweeter. It's just a different grade. And that's the stuff that services Northern America, well, and Southern America in fact, right? So the point is there, there's no supply risk to to WTI crude. You know, there isn't a war in the Gulf of Mexico, so you might think, well, okay, fine, those prices shouldn't move then. That's where this kind of thesis breaks down because of the correlations of these kind of price points. We have indeed seen WTI crude also rise. It's important to say rise not as much, So we talk about the spread between Brent and WTI. That spread, that's just the difference between the two grades, the prices of the two grades that has widened. So Brent crude prices have climbed more than WTI crude prices have, but still WTI's gone from $65 to $76. That's a 12-month high. So, you know, this does have a direct impact on petrol prices at the pump in the United States of America, even though there's no supply risk at all to WTI crude that's coming out of the Gulf of Mexico.

So, so one of the things I saw this morning, and, and also just a quick fact check, WTI, West Texas Intermediate.

Oh, sorry, what did I say?

I can't remember, but it wasn't intermediate.

West Texas Instrument, didn't I? That's because there's a company Was it Texas Instruments? Yeah.

What have you been picking up? Some calculators or something in your spare time for your daughter?

Oh dear.

Yeah. One of the things that I saw then that short term, because we'll, let's talk, we'll get into the long term because you just mentioned there about prices at the pump going up. There's midterm.

Yeah.

I want to get into this conversation about inflation and what it means to the economy for Trump. So in the near term, one of the things that was exacerbating, as you said, the continuation of day after day oil price gains has been that cargo ships have just been left dormant in the Strait because all the insurers obviously have pulled out because of this catastrophic kind of risk. No one's willing to insure these vessels on their passage. So what Trump actually said earlier this week that he ordered what's called the DFC, which is the international— this is the US International Development Finance Corporation. And they were going to act as a federal insurer for maritime trade. So bypassing the private sector, that he was going to come in and do that. It gets very complicated, but many people are saying it doesn't really move the dial a great deal. Yeah, it's interesting the tactics that he's tried to deploy to get the flow moving again. But yeah, going back to that point then, so prices at the pump. So maybe let's talk about the economic impact of what heightened energy prices have. And let's talk about specifically on the US economy, given it is Trump-led and also the meaningful impact it's going to have both on Fed policy and interest rates, but also the midterms.

Yeah. So let's talk US. Well, we'll come onto Europe in a minute and there is more of a natural gas situation than an oil one, to be honest. But yeah, from a US-specific kind of perspective, well then, you know, US, like again, kind of sort of historically, the US population, I mean, think about it geographically, it's a massive country, right? And kind of the trend of things has always been mostly, you know, families like they'll holiday inside their own country, right? Because it's so big and there's so many places to go and see and they'll tend to drive. And so kind of historically, the cost of fuel to fuel your vehicle has always been an incredibly sort of sensitive thing. And one the politicians always have, you know, very, very, very high up kind of on their agenda. So we'll talk about the midterm risk to all of this, but you know, from an economic point of view, as I've said, ultimately energy costs feed into everything, right? It feeds into the consumer side, feeds into the kind of producer side. And so if prices stay high for a longer period, and that's quite a key point here, will this conflict lead to sustained upticks in inflation that then prevent central banks from hiking— oh, sorry, from cutting rates. Sorry, we'll get onto hiking in a minute with Europe. Will that happen? It really all depends on how long this conflict lasts and obviously I don't have a crystal ball, so I don't know how long it'll last. How long will Brent crude stay well above $80? Dare I say, will it go a lot higher than that? Whilst you've got ships getting stuck because insurance companies won't insure them, I mean, that's one thing, right? But that is supply ready to go if the conflict dissipates. If you start to get actual oil production facilities targeted, damaged, destroyed, then you're talking about a much, much, much longer supply problem. So there's two, I think, two variables here. It's the how long this conflict lasts for and how much damage is done to infrastructure. Therefore, that really puts a measure on the supply risk. Now, the longer the supply risk goes on for, obviously, the greater impact it's going to have on the economy.

Doesn't one lead the other though? So let's say going off what Israel is saying at the moment, their appetite and desire seems highly motivated to keep this going on a prolonged basis, and therefore all the more consistent the retaliation effect and the probability of then infrastructure damage.

Yeah.

So on the balance of what we know today. Things are going to continue to be, it's going to be a multi-week thing at a minimum, it would seem at the moment.

Yeah. I mean, yes, I don't know. I mean, I'm not going to pretend to know, but the basic point is the longer it goes on for, the longer prices stay elevated and they're elevated, right? But they could, it could, there's easily scenarios where oil goes another $20 and breaks $100 $80 a barrel, right? I mean, then you really, really do have a genuine straight up kind of proper inflation problem. But right now at $80, you know, I said $80, it's an 18-month high, right? I mean, for Brent, for WTI crude, we're at $75. That's a 12-month high. These are high prices, but they're not wildly high. So I think at these levels, and if the conflict doesn't last very long, this is a little blip in a teacup, means nothing ultimately, and we crack on, right? But if they stay here for months or move higher, then obviously you've got a big problem. Now to put some numbers on it, very roughly speaking, so analysts have basically crunched it and super rough maths, back of the envelope. US GDP would reduce by about 0.1%. If you see oil prices kind of staying, well, or sorry, for every $10, I should say for every $10 of increase, US GDP basically drops by 0.1%. Okay. Now from an inflation point of view, then actually it's only about 6%. Of the Consumer Price Index that is made up of kind of straight up energy. So, but still it would have a kind of, there's obviously secondary impacts. It's not just the price of oil, it's then, well, okay, how does that, the longer prices stay high? Well, that means energy costs for companies go up and then right, they, their cost base increases, which means maybe you start to see product prices increasing. And then this is where you get this sustained inflation problem if this conflict lasts. But there is a counter to this though, from an oil supply perspective, I should say, because if oil prices stay high, well, actually this is good for shale producers in the US, right? There's so many variables here. If shale production's more expensive than the kind of more traditional kind of production methods, So if prices stay high, this is more profit margin for shale producers. They may increase production to offset some of that supply risk, right? And that's not even to mention the Strategic Oil Reserve.

So, which I think you've got to say, like, doesn't Trump have the bit of an ace in his back pocket here as a hedge where, like we saw when the Russian-Ukraine crisis started to kick off and Biden, I think it was back in 2022, last tapped the SPR, the Strategic Petroleum Reserve, which just quick, we've gone from geography to history class now. So the history class being that the way it would work is in post, well, prior to and post World Wars in the past, World War I, World War II specifically, What had happened is that obviously, as what we are seeing in current warfare now, but with drones, is that you try to target a nation's infrastructure to stop it being able to continue normal business. So what countries did, like the US, in that period, I think it was in the '40s, they basically stockpiled huge volumes of crude oil strategically across different parts of America. So rather than just having one epic massive warehouse housing hundreds of millions of barrels, it's strategically placed around the country in order to, in an old school fashion, you know, if airplanes were going to come over and drop bombs on your country, you've got different stockpiles located in different areas. Now in the modern day, then we've seen, I think it was, yeah, it was Biden, under Biden at the time, prices were rising. It was becoming politically unpalatable at that level. What do you do? And I think the last time it happened, I'm just looking at some stats here. I think these were like record-breaking numbers that they were like unloading onto the market to counteract this. I guess one perhaps contentious issue with this though is that I think when Trump came in, so January of last year, he was vowing to top up the SPR. Because of what I've just described, it had been drawn down quite heavily. But at the moment, it's still quite depleted. I think some of the percentage levels will vary depending on source, but my understanding is that it's just over half in terms of percentage capacity that it's at the moment. So that seems like something that would be a realistic thing to happen here if this goes on for another few weeks, do you think?

Yes, for sure. Especially with the midterms coming. I think this reminds me, we did a podcast, I don't know, like 2, 3 years ago maybe when Biden was just, it was like some kind of kid in a sweet shop, just gorging on this kind of strategic petroleum reserve for purely political gains. So there was no crisis, there was no conflict before he started raiding it. There were 714 million barrels in these reserves. Okay. And he started raiding it to keep petrol prices at the pump down to try and get his approval rating up. And we were talking at the time, this is a reckless political sort of strategy because, you know, there'll be a day where actually there is a genuine need to tap this supply because supply has been switched off because of some kind of crisis. Right. And so here we are. And so the problem is Trump's been trying to build it back up, but it takes a long time. Right. I think at its low in 2023, the supply after Biden gorged himself, got down to 347 million. So from 714 down to 347, right? Trump's been building it back up, but very slow. And I think we're about 400 and I forget the number now, like 415 barrels, apparently million barrels I should say. Right? So fine, we're about half full. So yes, there's still a lot of barrels and yes, Trump will tap it. For political gains, like every other politician in history. And it's just, there's, you say he's got an ace card, it's kind of been ripped in half. He's got like half an ace card and, but he'll tap it, you know, be sure about that. And so it's just that the US are just obviously more vulnerable 'cause they're kind of emergency supply. It's kind of half of what really they would've liked it to have been.

Yeah, I guess if you're talking about the sort of taco analogy with Trump, and then if you know that when he's being super aggressive on the foreign policy front, when oil's involved, this strategic deterrent, which is we can do that because we don't need your oil. We've got a massive stockpile, but if the 58% capacity starts to drop to 20%, and then he's still being very much the aggressor, but he's only got 20% left in the can. It's going to be, yeah, it'd be interesting to see his behavior at those points. So I guess it seems somewhat inevitable that he's going to tap it, but by how much?

The problem with that, sorry, I was just going to jump in. Apologies. Was, is to say, you know how markets work behaviorally. You know, if that real, if that emergency supply reduces and reduces and reduces to a point where there's not much left, prices are going to start to surge higher because now there'll be a perceived risk of, well, there's no safety net anymore. That'll inject a bit of panic into the market and naturally prices will rise anyway, exacerbating the problem. You know, even more requirement for the reserves that aren't there anymore. And you could, you know, worst case scenario, it kind of gets into behavioral sort of vicious cycle pushing prices higher. That's like the doomsday scenario, by the way. We're obviously not there yet, but something to kind of just have back of mind.

I like it. I like your thinking. So we talked about Trump and the administration and the economic impact. So what does that all mean for the Fed?

Yeah. Well, here's the problem. We were hoping, wanting, praying for more rate cuts this year. And so actually pre this situation in Iran, we were pricing basically 2 rate cuts in 2026. Okay, so here we are, we're at the start of March pricing 2 more cuts. Obviously this is off the back of cuts from the second half of last year, right? So right now, well, the chances of these cuts is obviously reducing because of this. So the primary effect is oil prices rise because of supply risk. The secondary impact is, well, then inflation expectations rise. The tertiary impact is then, well, hang on, central banks can't cut rates if inflation's moving up. And then, so you kind of, you go through the steps here and then the fourth impact is, well, Okay, confidence, you know, such an important thing. Confidence within the economy then reduces because, well, we were hoping for some rate cuts and cheaper debt, but now that's not going to happen. Maybe we should start to rethink our budgets and maybe just be a bit more prudent on spend. I don't know what order of effect we're on there. That has a 6th order of effect where then actually the economy does slow. Then jobs get cut. Which then speeds up the kind of contraction of the economy. So you see how it goes here. It's all these one, one, it's like, it's the domino effect. They call it that for this exact reason.

Can you cut spending when you're in the middle of a war?

Well, so indeed, right? So if you want to spend more on your military budget, you need to borrow more money. You know, in the US's case, like many countries, debt levels are already the, basically the number one kind of primary concern in many people's minds. So if you borrow more, your debt levels increase. This means your, if you like, your creditworthiness erodes, which means your yields go up. If bond yields rise, this actually pushes inflation higher. So it's such a convoluted but fully connected kind of ecosystem. And this is why it's like the butterfly effect, right? If you get this, the flapping of wings over here, as in, right, the US attack Iran, then the, it's just the ripple effects are everywhere. And it's why such a highly complex model. But to simplify it all, the longer oil prices stay high, the worse this will be from an economic point of view, obviously.

So it feels like then that the new Fed Chairman Kevin Walsh is heading for a direct collision here with Donald Trump because Trump's going to be going with every whim kind of to, in order to juice the economy short-term as possible. But in order to have those multi-order effect impacts happen, which takes time, Kevin Walsh is going to be handling a whole different proposition. So That's not going to look pretty, is it?

I mean, I forgot about Kevin Walsh. So he's turning up in a couple of months' time into office as Powell rotates out. Yeah, it could be a bit of a baptism of fire. So the midterm elections are in November. You know, so this is like halfway through Trump's 4-year term and you know, it's always a really, you know, as always midterms are important because it could change the shape of the Republicans' control within the House and the Senate, and it could therefore kind of basically kneecap Trump's kind of ability to push any kind of new legislation through, right? Trump's ratings are super low. There's worries, of course, like usual, the incumbent, the Republicans will usually lose and the opposition will tend to gain seats in a midterm. It's just the nature of things. And so, If the oil price at the pump situation starts to rise now and in the months ahead as we go into those midterms, yeah, that's a really bad look for Trump and he will for sure do everything he possibly can. So he'll tap the emergency reserve, he'll be all over Walsh to cut rates. You know his rhetoric towards kind of Powell in recent years, right? He won't kind of hold back. And he'll kind of lay the blame on the central bank's door to deflect the fault from his door. So all these shenanigans, you know, it's all coming.

So from a, just to step out of that for a second then, 'cause a lot of our listeners are thinking about, okay, so how are investment banks going to be performing? So we moving back to the era of where we were 18, 20 months ago. Where M&A activity starts to slow, even though we would seem like we were just getting real momentum at the moment between companies looking like jumbo listings coming down the pipe. Lots of press now, $1.75 trillion for the SpaceX IPO. But M&A deals slowing, but from the markets divisions, it's booming from like record anticipated revenues then from everything we've discussed, you would think.

Yeah. Look, let's step back here and actually UBS put out a piece, I think it was yesterday, which was just about, you know, global conflict, geopolitical scenarios. And ultimately they did an analysis, you know, and generally speaking, geopolitical flareups don't last very long. I mean, obviously there's clear notable exceptions to that, but in the main, the odds are that geopolitical flareups like this don't last. And therefore, you know, when you're starting to talk about, well, hang on, is this going to derail the kind of resurging M&A market? I mean, I think that's going too far. I think that is a bit sensationalist. Now I could be wrong if oil goes through $100 and, you know, it's $100+ in 3 months' time. For sure, all of those things are on the table, but I think for now that the likelihood of that is low. And, you know, I, if, you know, yeah, it's hard, it's hard to predict. It's such a live scenario, but I would say most likely at the moment you'd be in the most people, the consensus is that we're in the camp that this is going to be a shorter-term flare up, energy prices will restabilize, and ultimately this won't have a lasting impact on the economy. It won't have a lasting impact on inflation. Yes, the Fed might be able to squeeze in a cut or two this year, and that's the consensus at the moment. That's why you haven't seen, you know, wild move. I mean, okay, energy, yes. If you go to kind of stocks, well, Fine. You've had downside, but don't forget equity indexes were moving lower anyway. But actually, if you look at the S&P, where it's trading right now is where it was trading on Friday. Hasn't moved. So, you know, you're not seeing a broader spillout into other markets at this point, which proves my point that at the moment, the consensus opinion is that this won't last long enough for it to have a meaningful impact. Of course, that could all be wrong and we have to revise all of that as the weeks go on. But for now, that's the state of play.

Just to close then, one thing that also came out this week and a common conversation piece here has been inflation, is that in the euro area where we saw the release of February inflation data and that accelerated to 1.9%, so in Feb from 1.7%, and some of the other underlying numbers as well moving quite sharply. Higher. And I saw the markets, I think as of yesterday, so on Wednesday of this week, were pricing a 68% chance of a rate hike at the next meeting from the ECB, which I think is from 20%. So huge swing here.

You're telling me there's an odds-on—

Odds-on for a hike. And so inflation, because this inflation data obviously comes before this geopolitical flare-up. So I'm guessing that, like you said, inflation expectations are going to rise. Whether inflation itself gets the extra energy kicker, as we said, is on the duration of the conflict. It's going to determine as to what degree that actually materializes. But I guess people are thinking it's already moving up and now you've had this come on top to just act as a secondary kind of catalyst. But What are your thoughts on that? Is this one of these behavioral things that we always see where big thing happens, which is not completely, I guess, unexpected, but the timing certainly is unexpected and the speed of which it escalated perhaps was unexpected. And then we get that knee-jerk reaction. One thing leads to another, leads to another, and we have this big push-up in expectations. Only then for, as you said, rational minds to prevail once we start to just settle a little bit and look at the data, which history, as you rightly said, that UBS identified, says that actually these things tend to settle in time.

Yeah. Well, there's, I'd say there's two points I want to make. One supports the thesis that there's going to be a hike and one very much does not. The one that supports it, is just adding that kind of part to the jigsaw of natural gas and how Europe— so whilst we talked about oil there and the US aren't, you know, the US aren't dependent on the Middle East anymore for oil or gas, right? Europe is very dependent on Middle Eastern gas still. All right. Particularly coming from Qatar. And right now Qatar supply is just dead in the water. The insurers won't insure the boats. So it's off, the tap's off, right? Also, Putin loves an opportunity. So yesterday he stepped in and said, right, I'm going to reduce gas supply to Europe as well, just to kind of turn the screw. So look, for Europe, yes, there's a higher sort of risk here. And if you look at kind of LNG gas prices in Europe, then they've gone from about $32 to 55%. And that is the highest we've seen for, well, only for 12 months. It's like a 12-month high as well. A little bit like oil, I guess. But so look, there's a slightly higher inflationary impact to this crisis than in Europe than there is for the US. So fine, that feeds into this narrative. Okay, maybe they're going to have to hike rates at the next meeting. To kind of completely destroy that thesis though, the inflation print for February, which is before all of this stuff happened, was 1.9%. Yes, it was higher than expected, and actually the January reading was 1.7%. Okay, so it's gone from 1.7% to 1.9%. So if you look just at the last 2 months, oh, it's gone up. Oh no, no, we're going to have to hike. Yet if you step back and look at the last longer period, in the last 5 years, there's only been 4 inflation prints below 2%. One of them was February, 1.9%. So let's not get overly excited. It's, that's the 4th best inflation print in the last 5 years. And the trend, you cut one month doesn't make a trend, right? So the point is, yes, February was higher than January, but February was still lower than December and November and October. So the downtrend hasn't reversed here just off this one month's print is what I was saying.

On that point though, so that's the inflation, that's the official inflation data. So this basket of goods being measured and tracked. But if you were to look at consumer expectations in the euro area, which now earlier this year, the public is much more pessimistic than what the professional forecasts are like, whether it's the ECB or these numbers coming out. So 12-month expectations prior to the Iran situation, of which consumers are being fed the narrative that energy prices are going up, which you would imagine from behavioral consequence means that's going to probably push up prices just as a trigger, but their 12-month ahead inflation expectations were 2.6%. So it's almost a full percentage difference between what consumers are thinking and what the actual print is. How much does that come into play? Yeah, just given how they're influenced by media in this scenario.

It's a very interesting point. The last time inflation was at 2.6%, we had a print at that level in July 2024. But really it was sort of end of 2023, start of 2024 when it was kind of last there. Look, consumer opinion is volatile. And look, especially when you have a crisis like this one and it's all over the news, and obviously the news narrative tends to be, you know, latching onto the negatives and sensationalizing, which just feeds through to this consumer level. Confidence, which can be heavily impacted in short terms and swing back, you know, in a month or so's time. You know, you cannot set monetary policy purely off the consumer's sort of opinion. Okay. Monetary policy, this is because when you change interest rates, really, it actually takes about 6 months, 6 to 9 months. Like there's a thing called the transition mechanism, which is kind of measuring, right, the moment the central bank changes rates, how long does it take for it to feed through into the real economy in terms of the cost of borrowing? And it's like 6 to 9 months, right? So you're moving, you're changing rates today for a 6 to 9 month impact. So you can't now go, oh my God, consumers are panicking, right? Let's hike. 'Cause it's not going to have immediate effect at all. And actually all it'll do is make consumers panic even more. What you want is a steady hand on the tiller. Everyone calm down. You know, I, if I'm, if I was to bet, I, I don't think there's, I don't think the ECB are going to hike rates. 68% chance. I would say there's a 10% chance in my mind.

Is there anything from experience then that's making you feel, because again, I guess you're making that argument in the sense of that It is incredibly unusual for a central bank to change its policy direction from down to up or up or down with the interest rate cycle. And what, just to remind us, the ECB have had a spotted history with changing directions of rate hikes. So just for those listeners who won't remember or were engaged in markets at that point, what was that episode? That you were trading at that point in time?

Yeah. So in 2011, they had a monetary policy disaster. Let's, in my humble opinion, probably the worst couple of pieces of monetary policy decision-making in my career, which goes back to 2001.

Such a shame. He's my favorite central banker until he did that.

Hang on. No, no, no. This wasn't Draghi.

No, no, Trichet is my favorite.

This is Trichet. Yeah, exactly. That's right. Jean-Claude Trichet hiked rates, had hiked rates twice in the first half of 2011. This has just basically triggered and exacerbated the Eurozone debt crisis. But look, that's in the past. What you've said there is bang on, right? Where changing monetary policy cycle direction, that is not a small decision. And you do not make that on a whim, you know, just off the back of what could be a short-term effect. But you know, you often look at, well, how long do central banks stay at a steady rate before then changing direction? Really, the problem with that is our data's a bit messed up because rates stayed at zero for like a like a decade, right? Post-financial crisis. But if you take the hiking cycle after COVID, we hit the top in, this is the ECB now, 4.5% in September 2023. It stayed at 4.5% for 9 months. Then they started cutting the summer of 2024. Okay. We hit the bottom so far. So we're at 2.1, we're at 2.25%, if I'm right in saying, and we hit that in June of last year. So actually we would be 9 months by March at this kind of, at a stable rate.

Got yourself in the foot there. Yeah.

As I'm talking, I'm undermining my own argument here, but So maybe they have been long steady for long enough for a rate change, but still my main point still stands that, you know, I think you also need to take into consideration that Lagarde is coming towards the end of her term. And I don't think, yeah, when's that happening actually?

I can't remember, but I don't, I think from a legacy perspective, there's no need to take such a gamble. There's very little upside payoff. I would say, and obviously she shouldn't be making decisions on her reputation. That's like, that's a side issue to dealing with the economy at hand, but that does play an influential part of this in a kind of intangible way, I'd say. So, cool. All right. So at the moment, then this is a situation I'm getting from you that we can't make too many assumptions at this point as to the level of impact, as to the overall economic size of the impact, and also the implications it's going to have on the Fed just yet. We're going to have to monitor the situation extremely closely. The idea being history tells us that de-escalation is often the way and that behavior has maybe exacerbated some of the moves. However, things could get a lot worse quite quickly from a protracted encounter, particularly in Europe, feeling a more acute pain of the LNG on the gas side, given as you were describing. There is the possibility then under a more longer engagement in Iran of the Strategic Petroleum Reserve being tapped. That's likely to be a fairly go-to decision for Trump to take. Particularly if we start this going into, say, the summer ahead of the midterms in November. Yeah. So is that, is there anything else there that you'd say as final departing words?

Not really. I mean, maybe just look at shale oil production. Does that increase if prices stay high? Basically, look, if oil prices go above $100, just scrap everything I've said. And then I think we're into a different scenario. If they, if this flare-up doesn't last and the highest prices we see in oil is around about where they are now, this'll just be a little blip from an economic perspective and it won't have a lasting impact.

One of the things actually, just to finish on that makes me feel like this could go on a while is the type of tactics that are being deployed this time around where I think what happened before, you remember when they, the US and they had targeted the former head of the Iranian military, Soleimani, wasn't it? That they killed at the time. And then this was around that period of when Iran hit that Saudi facility and it was over a weekend. You had a 10% pop in prices. You remember that? I think that was 2022 maybe. Um, and then thinking about like the difference now, what I've been reading is obviously Israel has this and America have this amazing military technology, but then it was the cost of the actual systems that they're running and how military engagement has changed, namely through the Ukrainian defense strategies to deal with the Russians and how they're utilizing these really cheap kind of alternatives. And what actually Iran have been doing is deploying lots of cheaper drone technology, which flies under the radar of quite sophisticated, heavy-duty, otherwise traditional dominant defense systems. And it's a war of attrition. And actually Iran learned from previous encounters that actually they're holding back things like ballistic missiles, the more sort of meaty ammunition, trying to— meaning that the defense dome that Israel has costs a lot of money to keep running and can't be replenished quickly. So again, all of that talk, as much makes sense on the weaponry at the moment, kind of leads me to think that this is going to be a long one rather than a simple blip.

Yeah. But then Trump's gamble is that the Iranian people rise up and overthrow the administration, hence a short conflict, and he gets regime change. That's his gamble. Whether that happens or not, basically, I don't know. I don't pretend to know, but that ultimately will dictate the length of this, I would say.

All right. We'll wrap it up there. Thanks very much, Piers. We'll have our regular M&A show as well dropping on Monday. So make sure that you check that out, subscribe to the channel, and yeah, have yourself a great weekend ahead. Take care.

Thanks a lot.