Conflict has broken out in the Middle East, introducing a new layer of uncertainty for the economy and markets. The situation remains fluid, but we outline some of the potential implications of recent geopolitical developments for Canada, the U.S., and the broader global economy.

The Fog of Geopolitics

On February 28, the U.S. launched a large-scale military offensive against Iran following weeks of military buildup in the region. The escalation materially increased geopolitical risk and injected renewed volatility into financial markets. Equity markets retreated and bond yields edged higher in response to a sharp rise in energy prices amid worries of supply disruptions tied to a potential prolonged closure of the Strait of Hormuz—one of the world’s most critical energy transit routes.

In moments like these, we believe considering history provides valuable perspective. While geopolitical shocks often generate short-term market turbulence, occasionally severe, they have historically had limited influence on longer-term market direction. Across roughly two dozen significant military conflicts since 1950, the S&P 500 delivered positive returns twelve months later nearly three-quarters of the time. Markets typically adapt as uncertainty gradually gives way to clearer policy direction and improved economic visibility, making these episodes more transitional than structural in nature.

Nevertheless, military conflicts are inherently unpredictable. As such, the balance of risks surrounding the economic outlook has likely worsened at the margin. In our view, oil prices remain the key transmission channel to monitor. The $100-per-barrel level represents an important psychological and economic threshold, as sustained increases could adversely influence consumer spending and inflation. We expect financial markets will remain sensitive to energy prices in the near term, and a durable decline in oil would help build confidence that tensions are receding and market volatility could begin to normalize. 

Despite heightened uncertainty, macro conditions remain reasonably constructive. The world economy was on a sturdy foundation prior to the conflict, underscored by broadening growth momentum and strong corporate earnings trends. This suggests to us that businesses and markets entered this period of geopolitical tension from a position of relative resilience.

Takeaway

Renewed Middle East conflict has produced the expected reaction: uncomfortable volatility alongside sharply higher energy prices. The key unknown, which markets are struggling most to assess, is the length of the conflict. Inconsistent messaging from the U.S. administration has added to the uncertainty, limiting visibility for investors.

The economic outlook understandably feels less certain than it did two weeks ago, and we are closely monitoring for signs that financial or economic stress may be emerging. With a wider range of possible outcomes now in play, maintaining discipline becomes especially important.

While markets may remain unsettled in the short term, longer-term outcomes ultimately reflect fundamentals such as economic growth and corporate earnings trajectory. In our view, recent events continue to highlight the value of diversification and remaining aligned with long-term investment goals as a prudent approach to navigating inevitable periods of uncertainty.

Thanks for tuning in and see you in two weeks.