The Oil Price, AI, and a Strong Economy
When the Strait of Hormuz was closed, oil prices surged sharply. This immediately pushed up inflation expectations, leading to speculation about potential interest rate hikes by central banks. The next dominoes to fall were rising long-term interest rates and declining equity markets. The US dollar also strengthened, at least against the euro.
For some time now, however, this reaction pattern has changed. While falling oil prices are still viewed positively by equity markets, rising energy prices no longer appear to have much impact on stock indices, which continue to move higher regardless. How come?
Several explanations are commonly cited for this:
- It is clear that Trump wants to resolve the Iran issue as quickly as possible, as the conflict in the Middle East is highly unpopular both internationally and within the United States. The longer the conflict continues, the greater the likelihood that the Republicans could lose the midterm elections in six months’ time. This would be an unfavorable outcome for Trump, as a Democratic-controlled Congress would significantly restrict his room for maneuver. At the same time, Iran is also suffering from the current situation, making it logical for both parties to seek a peace agreement as soon as possible.
- Trump is expected to travel to China next week, and China — which has considerable influence over Iran — also wants the Strait of Hormuz reopened quickly. It is therefore quite possible that Tehran will come under too much international pressure to continue the conflict with the United States for much longer.
- Thus far, every decline in equity markets has ultimately proven not to be the start of a major downturn, but rather an attractive buying opportunity.
- When the Strait of Hormuz was closed, there were widespread predictions that shortages of gas, oil, helium, and fertilizer would soon emerge. So far, however, these shortages have remained limited. As a result, there has not yet been an immediate reason for panic.
- Finally, markets have repeatedly observed that whenever oil prices appear poised to rise sharply, Trump introduces a so-called “TACO” scenario, easing tensions once again. In this context, it is also notable that Trump has been publicly emphasizing the significant progress reportedly being made in negotiations with Tehran. According to him, an agreement is close.
There is, of course, another major factor driving equity markets steadily higher: everything related to AI. More on that below, but first a few comments on the points above:
- Trump has little choice but to maintain that the ceasefire is holding and that the war is effectively over and won. If he were not to do so, he would need Congressional approval to continue the conflict further — approval he would almost certainly not receive. Such an outcome would represent a major political humiliation for both himself and the United States.
- When Trump says he is receiving very positive signals from negotiations with Iran, this is probably true — but from which faction within the Iranian leadership? Most likely from the official government, which in reality does not hold ultimate authority. The Revolutionary Guard effectively controls the country and reportedly owns more than 50% of the Iranian economy. It is well known that they are unwilling to concede to most American demands, particularly regarding enriched uranium. They also appear prepared to accept substantial civilian casualties if necessary. Furthermore, they favor keeping the Strait of Hormuz closed, as this increasingly weakens Trump’s domestic political position.
- Trump has stated that he intends to reopen the Strait of Hormuz by having the US military protect commercial shipping. However, defense experts we have consulted believe this would be extremely difficult to implement in practice.
- Finally, while significant physical shortages have not yet materialized, most experts believe such shortages could still emerge in the near future.
Our conclusion is that the situation surrounding the Strait of Hormuz remains highly uncertain and could easily lead to substantially higher oil prices. So far, the global economy has been able to absorb the higher oil price environment, but if prices rise much further, the negative economic consequences are likely to become considerable. In our view, equity markets are currently underestimating this risk.
That said, markets may still prove correct. It is possible that the rise of AI will outweigh the negative impact of higher oil prices. Enormous sums are currently being invested — both this year and next — in AI development and the construction of data centers. In the near term, this is highly supportive of economic growth and corporate profitability.
Unfortunately, the outlook is not entirely positive. AI also has clear downside risks. As competition intensifies, profit margins could eventually come under pressure rather than continuing to expand. It is also conceivable that governments may at some point decide to redistribute a portion of the sector’s substantial profits to support those adversely affected by AI-driven disruption.
It is therefore entirely possible that equity markets are currently pricing in an overly optimistic future scenario. Current valuation multiples appear to underestimate the possibility that developments could prove less favorable over time — both with respect to the Strait of Hormuz and oil prices, and to the long-term profitability of AI. This is not to suggest that AI will soon have a net negative impact, but rather that current market sentiment may reflect excessive enthusiasm.
Read more on this and related topics in our latest Global Financial Markets Report
