Market Insights

Conflict has broken out in the Middle East, introducing a new layer of uncertainty for the economy and markets. 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

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. While geopolitical shocks often generate short-term market turbulence, they have historically had limited influence on longer-term market direction. 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.

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.

Global and U.S. Implications

Energy markets have been exceptionally volatile, with oil prices moving within a wide range as investors attempt to gauge the likely duration and intensity of the conflict. The impact is likely to vary significantly across regions, particularly between energy-importing and energy-exporting economies. Europe and much of Asia remain heavily reliant on imported energy, leaving them more vulnerable to higher inflation and weaker growth if oil prices stay high. On the other hand, the U.S. appears somewhat better positioned to absorb an energy shock. Their position as a net energy exporter reduces its direct exposure to supply disruptions. Reflecting these dynamics, U.S. equities—while lower since hostilities began—have held up better than international peers, while the U.S. dollar has strengthened against most major currencies. That said, a prolonged period of elevated oil prices would still represent a headwind for the American economy by placing pressure on discretionary consumer spending and raising input costs for businesses. Meanwhile, the combination of potential inflationary pressures and slower growth could complicate the Federal Reserve’s policy outlook, with markets recently paring back expectations for near-term rate cuts.

Implications for Canada

Canadian equities have also declined since the conflict began, though the S&P/TSX Composite Index remains in positive territory year-to-date. The Canadian market’s significant weighting in the Energy sector has provided support, helping to offset weakness in other sectors. Energy accounts for roughly 15% of Canada’s goods exports and about 6% of GDP, suggesting that the country could see some modest economic benefit from higher oil prices.

However, Canada’s ability to fully capitalize on rising prices is constrained by limited pipeline capacity, which restrains how quickly exports can increase. Higher oil prices have mixed economic effects: higher revenues for energy producers and governments, but higher fuel costs for households and businesses. For interest rates, the potential for renewed inflationary pressure tied to the conflict has added uncertainty to the outlook for the Bank of Canada’s benchmark rate, with futures markets now pricing in some probability of monetary policy tightening in the second half of the year.

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.