Oil Climbs as Israel-Iran Conflict Amps Up Market Risks
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Bloomberg Audio Studios. Podcasts. Radio. News. Welcome to the Bloomberg Daybreak Asia podcast. I'm Doug Krisner. So today's focus will squarely be on this escalation in tensions between Israel and Iran. The two sides exchanged attacks for a third day in what's fast becoming their most serious entanglement yet.

There were Israeli strikes on Iranian energy assets over the weekend. So not surprisingly, some of the biggest market reaction that we are seeing and have seen is in the crude oil space. Now, in New York on Friday, WTI at one point was up 14 percent week

We closed 7% higher. And right now, the bias continues to be to the upside. Joining me now for a closer look is Pavel Malchanov. He is investment strategist at Raymond James, joining from Charlotte, North Carolina. Pavel, thank you so much for making time. How are you assessing risk right now? So we need to differentiate between sentiment and substance, as always.

In the near term, prices can go absolutely anywhere based on a sense of panic, uncertainty, all of which influence investor psychology. A little bit further ahead, however, what matters fundamentally is, is there going to be actual supply disruption from the Middle East? That could include Iran itself.

That could include disruptions to marine shipping that the Houthis in Yemen, allies of Iran, might perpetrate. The worst case scenario would be if Iran, as has been speculated for decades, might mine the Strait of Hormuz through which 20 percent of the world's oil passes.

For now, all of this is in the realm of theory, but the oil market seems to be pricing in something a lot closer to a worst-case scenario than what we have today. We had analysis recently from JPMorgan Chase. They predicted the closure of the Strait of Hormuz could push oil

international crude prices as high as $130. But because we're talking about energy and the connection here with inflation expectations, is that one of the reasons that we are seeing kind of a breakdown in traditional safe haven plays, particularly U.S. treasuries? Well, the dollar has been weak ever since the trade war started earlier this year. So that certainly is a factor that

is also a source of uncertainty to investors separate and distinct from the Iran crisis.

But going back to the $130 a barrel, standard rule of thumb in the oil market is if 1% of oil supply gets disrupted, prices go up by 5%. That's called elasticity of demand. So if we were to lose, in theory, 20% of the world's oil supply through the Strait of Hormuz,

You could see prices double, which would put us kind of $130 to $150 a barrel. Now, would they stay there? No, of course not. Number one, sustaining that level of oil prices would absolutely kill the global economy. Even more to the point, we are protected from fuel shortages.

Because the International Energy Agency and all of its members, including the United States, have government-controlled strategic reserves, the U.S. SPR, exactly for this type of eventuality. So nobody needs to be worried about gasoline lines or any of what people might remember from the 1970s.

Just as Russia's war in Ukraine three years ago also caused a brief spike in the oil market. But once those reserves began to be released, prices came right back down. So we have a Fed meeting in the week ahead and policymakers have already been clear about the questions around tariff policy, immigration, tax policy.

This conflict between Israel and Iran introduces another element of uncertainty. Where does it leave the Fed? Well, for this coming meeting, we think the Fed will keep rates unchanged. Our expectation is as the inflationary effects from the tariffs increase,

remain relatively kind of under control, restrained into the second half of the year, that should allow the Fed to cut twice. So not this coming meeting, but looking into the second half. Iran crisis obviously is one of these exogenous events that always wreaks havoc

with anybody's models and predictions. I don't think the Fed is going to take this into account right off the bat because, you know, the crisis could could escalate dramatically in the coming weeks or it could subside. So making decisions, you know, just a few days into it would really make no sense. To what extent do we need to reprice the outlook for inflation very quickly, Pavel?

Well, oil or energy in general is about 8% of U.S. consumer spending. Of course, that includes electricity and natural gas, not just oil. If oil prices were to get to that $130, $150 worst-case scenario, number one, it would not last.

And number two, it would itself damage the economy so severely that the Fed would probably start cutting rates to avoid an altogether recession.

I think the most important thing is we should not assume that type of oil price scenario actually occurs unless we see physical supply from the region being disrupted. There is no evidence of that today. Pavel, we'll leave it there. Thank you so much for your time. Pavel Machanov is investment strategy analyst at Raymond James, joining from Charlotte, North Carolina, here on the Daybreak Asia podcast.

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Welcome back to the Daybreak Asia podcast. I'm Doug Krisner. Stateside, it's a holiday-shortened week. Markets will be closed on Thursday to observe Juneteenth. And as we mentioned a moment ago, we've got a Fed meeting that will wrap on Wednesday. In terms of the economic news, retail sales on Tuesday, and economists are expecting an overall decline primarily due to fewer motor vehicle purchases.

Joining me now for a look at the U.S. macro is Patrick Kennedy, his founding partner at AllSource Investment Management. Pat, thank you so much for making time to chat with me. Talk to me a little bit about how you see the American consumer right now dealing with maybe a different tax regime, certainly dealing with the impact of tariffs. And now we're going to have to include into the mix higher oil prices.

Hi, Doug. Thanks so much for having me back on. And I would agree that there's a lot of uncertainty out there right now, to say the least. So I think we talked about this in episodes past. We think we're in a different regime and that we had a clear regime shift in markets in 2022. And what this new regime looks like is heightened geopolitical risk, high

higher rates, ongoing concern about inflation, and then overall volatility within markets. So if you talk about consumer mentality within that, and then you throw on top of that what just happened within the Middle East and then higher oil prices, your average consumer is not quick to go out and spend another buck. I think most people are concerned about the overall impact with

tariffs and now higher oil prices. And that's definitely making an impact in household decisions when it comes to spending. It's funny, there was actually a study that was done by Walmart a while back on oil prices. And there was a direct correlation with how much people would spend at Walmart compared to the price of gas. And it was really pretty simple. It was if they planned on spending, let's say, $80 at the pump,

they spent 60, you can almost guarantee that that extra 20, they'd go inside and spend it at Walmart. So knowing that oil prices have gone up, it's got to have an impact. Oil prices can certainly rise a lot more quickly than they can come down. So let's assume for the moment that

We get stuck here maybe around $75 the barrel on WTI and the extent to which American businesses begin to feel the impact of higher energy prices. Would you expect them to be able to pass on that increase to consumers? Or are things still so precarious right now, given the situation with the tariffs, that if you're an American business person, you might be a little reluctant to pass on that higher cost?

I would go with the latter, Doug. I know that their recent inflation print was softer than expected. And, you know, most market participants thought that was a good thing. And trust me, myself included. But the fact is, we really haven't seen the tariff impact yet to the overall data. Right. In the next three to four months, we should see some sort of impact. And, you know, the fact the fact of the matter is we're going to see it somewhere. What are you betting in terms of Fed policy this year up until this point?

the conventional wisdom, we were going to get two rate cuts between, let's say, now and the end of the year. Maybe the first is in September. Is that still your thinking?

I think that when we talked about this three to six months ago, we still very much thought the Fed was concerned about inflation and that they were going to be very cautious on when they lowered rates. We have since changed that stance a bit and think that the Fed is now concerned more so about growth.

And if we start to see some of the economic data come in weaker, the Fed will most likely act quicker because of the concern of a recession. The things that we've done, you know, such as tariffs and some of the geopolitical changes

unrest that we've seen. We haven't seen this sort of thing in a very long time. And therefore, I think the Fed is going to be more cautious on the growth side and be quicker to cut now than be concerned about inflation. So if you're concerned about weaker growth, do you become defensive in the equity market? Do you maybe take shelter in the bond market? What's the strategy?

Yeah, great question. So we've kept a hedge on all throughout the year. And as you know, we're very big into alternative investments in private markets. Our overall view is private markets will have less of an impact from tariffs, from higher oil prices than public markets will. And it's just because there's not as much of a multinational impact with some of these private equity companies.

When you look at hedge funds, they operate in a very different manner than a long-only mutual fund. They always have some sort of hedge on, which is why we like them right now. I think the public equity markets are pretty complacent right now. So we're almost back to all-time highs, yet we still really haven't seen the impact of tariffs. And now there's war breaking out in the Middle East, and not to mention what's still going on in Ukraine, right?

So our view is that you know the public markets are a bit frothy right now we still like sectors within the public markets right so. We think that cyber security makes a lot of sense you know trade that we did earlier in the year one of our managers did was European defense sectors simply because Europe is now going to have to start spending money.

on defense for the first time in a while since the U.S. is pulling back on that. That's worked out really well. So we think it's more of a, I hate to say it, but a stock picker's market, right? We think you need to know where you're exposed. Certain sectors, certain stocks make sense. But from an index level, we think we're pretty frothy at this point. So you mentioned Europe there, Pat. How are you feeling about markets in the Asia-Pacific?

Yeah, I think with everything going on with China, we're staying away right now. We still like India a lot, and we like Japan a lot. India has really opened up in a big way. Their public markets have done phenomenally well. Back in 2015, the Digital India project kicked off, so government is definitely opening

pushing for innovation, spending money on innovation. That's always a good thing. You're starting to see some of the large private equity players take notice and flows start to go towards India. Japan is very much the same story. So inflation has actually been a good thing for Japan. They've gotten out of a 20 year deflationary period because of this. And it's worked out really well. We're seeing a lot of innovation over there as well. So that's kind of the two areas that we would pick as far as emerging markets go.

China, we're still very cautious on because of the ongoing trade negotiations and the higher than normal tariffs. Before I let you go, Pat, I have to ask about how you're feeling these days around the artificial intelligence trade and if you're still positive how you're playing that.

Yeah, you know, we've yet to see AI monetize in a big way. We're still very much about selling shovels in the gold rush, so to speak. So we like NVIDIA, you know, but even NVIDIA, the growth story has kind of happened there. We still think there's a lot of growth ahead of that company, don't get me wrong.

just don't think you're going to see a 10x anytime soon right so the private markets are just now starting to pick up on that theme you start to see a lot of things going on with natural gas as a way to power some of this ai which is why we like to play it so we're looking at some of the some of the secondary markets of ai if you will such as natural gas such as data center

such as software. When it comes to just AI companies themselves or betting that we're going to see a huge multiple expansion in some of these hyperscalers because of AI, we think that we really need to see the results first before adding a lot more dollars there. Pat, we'll leave it there. Thank you so much. Always a pleasure. Patrick Kennedy is founding partner at AllSource Investment Management, joining us here on the Daybreak Asia podcast.

Thanks for listening to today's episode of the Bloomberg Daybreak Asia Edition podcast. Each weekday, we look at the stories shaping markets, finance, and geopolitics in the Asia Pacific. You can find us on Apple, Spotify, the Bloomberg Podcast YouTube channel, or anywhere else you listen. Join us again tomorrow for insight on the market moves from Hong Kong to Singapore and Australia. I'm Doug Krisner, and this is Bloomberg.

Thrivent can help you plan your finances for the people, causes, and community you love. What makes Thrivent different? Financial services and generosity programs are combined to help you build a financial roadmap for the future, while also creating opportunities to give back along the way. Visit Thrivent.com to learn more.

Thrivent, where money means more. How can you grow your business from idea to industry leader? Bring your vision to life with smart business buying tools and technology from Amazon Business. From fast, free shipping to in-depth buying insights and automated purchase approvals, they deliver everything you need to achieve your goals.

It's not easy to stand out from the crowd. Simplify how you stock up to get ahead. Go to AmazonBusiness.com for support. This is an iHeart Podcast.