Investors over the past year have learned that Donald Trump has a boundless capacity to quickly reverse course in the face of acute political or market pressures.

But a week since the United States and Israel launched missile strikes on Iran, there are fears the war could morph into a protracted conflict.

In purely economic terms, the war has brought about what has long been considered a worst-case scenario from a conflict in the Middle East: the closure of the strait of Hormuz, through which travels a fifth of the world’s oil and gas supplies.

Since the start of the hostilities, the global benchmark oil price has jumped by 17% to more than US$85 a barrel, triggering shock waves through financial markets.

The Australian sharemarket has been relatively shielded from the worst of the fallout, but still suffered a steep 3.8% loss for the week.

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Asian markets, many based in countries heavily reliant on imported energy, were battered.

In South Korea, the stock market collapsed by 13% in a single session to record its worst day in history.

But on Wall Street, the S&P 500 index had lost less than 1% leading into its final session on Friday night.

Just another shock

As the Trump administration on Friday mulled using America’s strategic oil reserve to take some of the pressure off prices, Shane Oliver, the chief economist at AMP, said he was worried that “markets are a little bit complacent”.

“The mildness of the response has surprised me,” Oliver said.

“And that partly reflects the experience of the past year or so with Trump, where there have been numerous shocks – especially around American tariff announcements – and then we get some sort of backdown.

“Markets are assuming there will be some sort of backdown and this won’t be a long, drawn-out war.”

The essential challenge for investors is that it’s not clear why Trump decided to launch the war, and therefore what it will take to end it.

That has left markets in a holding pattern: priced for a sharp but relatively short conflict that lasts for another two to three weeks, but not for months.

It’s a high-stakes bet, but a defensible one.

The fact that the Australian dollar has held above 70 US cents is testament to the relatively sanguine response to what is being referred to as the third gulf war.

Ray Attrill, the head of foreign exchange strategy at National Australia Bank, said the Australian dollar’s resilience in part reflected the fact that Australia is a major energy exporter through our LNG and coal resources.

“With oil prices in the 80s, the underlying assumption is that oil will start travelling through the strait of Hormuz sooner rather than later, and the big disruption will not last too long,” Attrill said.

Bets placed in derivatives markets suggest oil prices will be back into the US$60s or US$70s within a month.

But a much larger and prolonged shock would send the dollar much lower, Attrill said.

“If that assumption starts to get challenged, then oil at US$90 or US$100 starts to become very viable. And in that environment, there would be a much deeper sell-off.”

Oil’s stagflationary impact

An oil price shock is stagflationary, as higher fuel costs push inflation higher even as they hurt growth.

It’s a dynamic that puts central bankers in a bind: hike rates to contain inflation, or ease monetary policy to support the economy?

This is not the 1970s, when a doubling in the oil price drove inflation and unemployment in Australia into the double digits.

Which is not to say there hasn’t and won’t be any impact.

Jim Chalmers this week warned of the potential for “substantial” consequences on the local and global economy as a result of the war.

For now, the focus is on what higher oil prices mean for inflation, and interest rates.

NAB economists estimate that inflation is now likely to peak at about 4.75% in the year to June, or half a percentage point higher than predicted before the start of the Iran war.

That’s with Brent crude prices around current levels.

A sustained move towards $US100 a barrel, they calculate, could push inflation above 5% and to its highest level since late 2023.

Those types of figures show why investors, central bankers, and politicians around the world are so fixated on the oil price.

Michele Bullock, the Reserve Bank governor, on Tuesday made it clear she was alert to the risk that climbing petrol prices would entrench views that inflation would stay higher for longer, which can make it harder to bring price pressures back under control.

The RBA typically looks past temporary price shocks, but Bullock said it was not clear that was the right approach.

“This one might be a little bit harder, because … we already have elevated inflation, and I think there is a risk that inflation expectations might become a little bit unanchored,” she said.

This time could be different

Brett Solomon, a senior portfolio manager in QIC’s fixed income team, said investors have become accustomed to geopolitical uncertainty over recent years, but that this time could be different.

“Over the last few years investors have seen geopolitical headlines only last for a week. We’ve seen that many, many times. So we’ve become accustomed to that,” Solomon said.

“What is different this time is that this could be longer lasting, and that could be a really big difference.”

Solomon said that, for now, he was sticking with a view that the RBA would hike one more time in May.

But he, like other investors, will be watching to see whether oil prices move high enough for long enough to trigger central bankers and investors to fundamentally reevaluate their positions.

Kerry Craig, a global market strategist at JP Morgan, said the “base case for most hasn’t changed: that this won’t be something that drags on for months, and the outlook for the global economy is fairly decent”.

“Really when you change that view, it’s because you think we are now heading towards recessions.”