The US-Iranian snake pit

Iran has begun increased its stockpiles of uranium and increased its uranium enhancement in response to the pressure being applied by the US since the latter withdrew from the 2015 nuclear deal. What are the chances for further escalation of tensions between the US and Iran and what do these tensions mean for investors?

Iran has sought to goad Europe, Russia and China into providing relief from sanctions introduced since the Americans withdrew from the Joint Comprehensive Plan of Action last year. In particular, at the start of July, Iran said it had exceeded the limit set on stockpile of low-enriched uranium under the 2015 nuclear deal, and a few days later declared that it had breached the limits on the degree of uranium enrichment.

If Iran did move to obtain nuclear power, Trump administration might eventually feel it has more leeway for possible air strikes. If that happened, the Trump administration and its hawks would conceivably stop at nothing to cripple Iran’s ability to restart its nuclear programme. That could involve heavy air raids and missile strikes against Iran’s nuclear installations. But such a prospect is a long way off at this juncture.

At this stage, the US president seems more cautious about the crisis than his tweets might suggest. The closer we get to election time, the less likely it is that a large-scale military campaign will be on the president’s agenda. Granted, the president’s coterie includes figures who are in favour of the military option. Even so, the president has made it clear that he is in command and the final say is his.

So far, neither the price of crude nor financial markets have been much shaken by the rising stress in the Gulf. There are two possible explanations for this relative calm. One is that market participants are complacent and focused more on the resumption of looser monetary policies by central banks. Consequently, risks that are not strictly economic such as geopolitical risk (always hard to assess) are ignored.  Conversely, we may be witnessing a fair appreciation of geopolitical events. Ultimately, neither the US nor Iran wants war. Investors correctly surmise that the war of words and the isolated incidents are merely gesticulating and do not risk spoiling the global economic and financial backdrop.

While we can currently assume that Iranian and US leaders are thinking rationally, and large-scale military conflict is not the most likely outcome, a dangerous chain reaction cannot be ruled out. Investors need to keep a close watch on this complex game of chess in which the pieces are moving all the time. A diversified portfolio that has a fair but not excessive share of risk assets with mechanisms to cushion against sudden negative events is the most suitable response to the situation in the Gulf and elsewhere.

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