Markets have grown more hopeful after reports that a potential U.S.-Iran agreement could include reopening the Strait of Hormuz, a development investors see as removing one of the larger geopolitical risk premiums that has weighed on global assets in recent months.
President Donald Trump said over the weekend that a deal with Iran was "largely negotiated," and multiple media reports indicated the accord might provide for restoring normal shipping through the critical waterway. Those headlines provided a lift to risk-sensitive assets and currencies, even though the president subsequently sought to temper expectations by downplaying the likelihood of an immediate breakthrough.
Despite the uptick in sentiment, Capital Economics - led by Thomas Mathews - warns that any market rally sparked by a reopening may be smaller and narrower than many investors hope. The firm highlights three principal reasons why the potential relief could be muted.
1) Energy prices are unlikely to snap back immediately
First, Capital Economics argues that oil and gas prices would not necessarily revert to pre-conflict levels right away if the Strait reopens. That persistence in energy costs would continue to impose a terms-of-trade shock on major energy importers, especially economies in Asia and Europe, and would keep inflationary pressures elevated. The firm frames this as an important constraint on how quickly financial markets can shrug off the geopolitical shock.
2) Monetary policy expectations have shifted
The second consideration is central bank policy. Higher energy prices and stickier inflation have already pushed expectations for rate cuts further into the future. As a result, bond markets may find it difficult to produce a sustained rally even if geopolitical tensions ease. "Rate cuts are probably off the table this year in most major economies even if the war ends," the firm said, noting that some markets where investors still expect relatively high rates - such as the U.K. - could register a stronger reaction than the United States.
3) Risk appetite has held up through the conflict
The third obstacle is that investor demand for risk has remained surprisingly resilient throughout the disruption, which reduces the upside available from a simple de-escalation of tensions. Capital Economics observes that while certain sectors have lagged and valuations in some areas remain below pre-war levels, much of this underperformance reflects higher bond yields rather than widespread investor panic.
Mathews also flagged one market that could benefit if the Strait reopens: the yen. "One that might benefit is the yen; if nothing else, re-opening the Strait is probably necessary to avoid further intervention," he said, pointing to stresses on energy-importing economies and their currencies during the disruption.
Looking ahead, Mathews suggested that renewed gains in equity markets are more likely to be driven by earnings growth - particularly within technology - than by a renewed, broad-based surge in risk appetite.
Implications for investors
In short, while the prospect of restored shipping through the Strait of Hormuz is positive for market sentiment, Capital Economics cautions that three structural forces - lingering elevated energy prices, a delayed pivot in monetary policy, and already-robust investor risk appetite - could all limit the breadth and depth of any ensuing market rally.