Oil prices could remain elevated and inflation concerns could linger even after the situation in the Middle East is resolved, though markets reflect expectations for a quick return to normalcy.

On April 1, Michael Miranda, President of BMO Family Office and Head of Investments, BMO Private Wealth North America, moderated a special discussion examining how the evolving Middle East conflict is influencing financial markets and the broader macroeconomic outlook. “Middle East Conflict: Economic and Market Ripple Effects,” featured:

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  Randy Ollenberger, Managing Director, Oil & Gas Research

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  Doug Porter, Managing Director and Chief Economist, BMO

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  Brent Joyce, Chief Investment Strategist and Managing Director, BMO Private Wealth

Listen to the Markets Plus podcast based on the discussion:

Here’s a look at some of the key themes covered during the event:

Consumers may be feeling the sting of high gasoline prices, but equity markets are signaling that crude oil and natural gas prices could return to some normalcy by the end of April, explained Randy Ollenberger. However, he cautioned about how quickly energy prices would return to where they were earlier in the year. Brent Crude continues to hover near US$100 a barrel and refined oil products sit near US$150 a barrel because the physical effects of disrupted oil deliveries are only now starting to be felt.

With the Strait of Hormuz remaining largely closed to traffic, Ollenberger expects to see the risk premium on oil remain elevated for some time. “The biggest risk here is that the physical shortages are just starting to emerge,” he said. “There’s a risk that investors are a bit too complacent, because we haven’t seen commodity prices spike as high as the worst-case scenarios.”

He added that it will take time for the physical market shortages to correct, particularly in product markets such as jet fuel, gasoline and diesel, even if there is a quick resolution to the conflict.

Every day that crude prices remain elevated has a material effect on the economy, said Doug Porter. He’s noted in previous BMO events focused on the Middle East that every 10% sustained rise in oil prices adds about two-tenths of a percent to inflation in both Canada and the U.S. “Sustained” is the key term, he said, but added that “we are expecting oil prices to come back down through the summer and fall.”

“Where we think we get into the danger point is if oil prices get up to around US$120,” he said. “At around US$150 a barrel, then we're talking about the real risk of a downturn in the global economy and the North American economy as well. Fortunately, we're still shy of that, but it is significant enough to have us shaving our growth.”

Based on the current environment, BMO forecasts roughly 1% growth in Canada this year and about 2% growth in the U.S. The question markets are asking now is what this means for interest rates. Some inflationary pressures are already starting to appear globally. Looking ahead, Porter expects inflation will likely average slightly above 3% in the U.S. this year and close to 3% in Canada.

Porter said the initial market reaction to the conflict was to remove expectations for the Federal Reserve to cut rates for the rest of the year, but now the market is starting to price in a chance for a rate hike. As for BMO, “Our view is that for the Fed, we still believe that ultimately they will trim interest rates,” said Porter. “But what this conflict has done is push the timeline back. The earliest I could see the Fed cutting rates at this point would be September.”

Likewise, the outlook for the Bank of Canada (BoC) has also been in flux. For this cycle, Porter expects the BoC to remain on hold.

Near-term volatility aside, the thing that has impressed Brent Joyce about the markets has been their resilience. Through COVID-19, inflation spikes, the ongoing Russia-Ukraine war, tariffs, and now tensions involving Iran, North American equity markets have continued to rise. Over the past 10 years, there’s been a threefold increase in returns from North American equity markets. The S&P/TSX Composite has experienced 12% compound annual growth over that period, while the S&P 500 has compounded at 14%.

“When we’re talking to investors in times of uncertainty, that's testimony, evidence, and faith that investors, households and businesses can adapt and pivot,” he said. “We've had innovation that's helped through that as well.”

No matter when the conflict ends, the global economic impact will linger for some time. For instance, the closure of the Strait of Hormuz could affect the supply of helium, a vital input into the production of semiconductors.

A recent attack on an aluminum plant in the region could push prices for the metal higher, even as demand for other metals is falling around the world. Porter wonders about the implications this might have for Canada’s aluminum sector, which continues to face a 50% U.S. tariff.

Could that be one of the factors that influences renegotiation of the USMCA trade pact? Perhaps, he said. “There is an optimistic scenario here that Canada has been a little bit under the radar from the U.S. point of view and that maybe this slightly improves the chances that we will get a reasonable accommodation on the USMCA, simply because the President would like to move above and beyond and get a win on this before the midterm elections,” he said.