The US announcement on 8 April of a two-week ceasefire with Iran led to a relief rally of risk assets. However, the prospect of a peace deal and, hence, the sustainability of the truce, is still uncertain. This suggests that global markets are entering a phase of two-way risk – renewed escalation leading to closure of both the Strait of Hormuz and potentially the Bab al-Mandeb Strait or further de-escalation leading to re-opening of the Strait of Hormuz and gradual resumption of global trade and energy supply.
The upside
Since the US/Israel-Iran war started on 28 February, markets have gone through significant inflation repricing: Bond yields have risen, yield curves have shifted higher with a bear-flattening move. Some market players have even expected the Fed and the ECB hike rates along with the BoJ. Now with the ceasefire announcement, some of these market moves and expectations should reverse.
A further de-escalation case should take markets back to the broadly benign risk-on trades that were prevailing before the war. There will be renewed appetite for risk assets, including equities, high-yield debt and EM local debt. DM yield curves could even steepen again as rate hike worries give way to concerns about fiscal positions and debt burden. This upside scenario for risk assets should be easy to understand as the markets have seen it before the war.
The downside – a potential nightmare
What’s more intriguing is the case of further escalation because the markets have not seen it before. One likely scenario is that Iran, as it had already warned, could also close the Bab al-Mandeb Strait in addition to keeping the Strait of Hormuz closed. That would amount to a nightmare scenario for the global economy.
The 32-km strait is the only entry point for the passage from the Indian Ocean to the Red Sea through the Suez Canal out to the Mediterranean Sea (see map). Its narrowest point is only 26 km wide, limiting traffic to two channels for in- and out- bound shipments and making it a crucial strategic chokepoint. If this route is closed, ships must go around Africa, adding 14 days to delivery schedules.
While the Strait of Hormuz handles 20% of global oil and gas shipment and 30% of global fertilizer trade, the Bab al-Mandeb Strait handles 12% of global trade including 20% of food and agricultural products and 5% of oil and gas shipment.
Iran-back Houthis1 controls Bab al-Mandeb. They have entered the war since late March and shutting Bab al-Mandeb would be their effective weapon against the US-Israel coalition. The Houthis already shutdown Bab al-Mandeb effectively, by attacking ships going through the Strait, during the Israeli Palestinian conflict over Gaza in 2025. They could easily do it again.
So, if both the Strait of Hormuz and Bab al-Mandeb were shut, they could cause a massive, unprecedented shock on global energy supply and trade by disrupting 25% of the world’s oil and gas and over 20% of global trade, including agricultural products. Such an escalation would take a big toll on risk assets, including equities, credit, and global FX but boost the prices of oil, gold and the USD.
[1] The Houthis is a Yemen-based group and is a central part of Iran’s so-called “Axis of Resistance” – a coalition of groups ideologically or tactically aligned with Tehran.
