New Middle East crisis could trigger a big spike in volatility warns BCA Research

Market volatility is expected to spike again as investors begin to take into account the prospect of rising oil prices amid the latest Middle East crisis and slowing global economic growth, strategists at BCA Research said Wednesday.

The research firm upped their subjective odds of a major oil supply shock to 37% and emphasized the 60% chance of Republican victory in the upcoming election.

“Tactically investors should stay overweight energy stocks relative to other cyclicals and favor oil producers in the Americas rather than Middle East,” BCA Research said in a note.

Fighting between Israel and Hezbollah is intensifying. The situation escalated further after Hamas’ top political leader was killed in an airstrike in Tehran this week, with Iran blaming Israel and vowing revenge. The U.S. has also conducted preemptive strikes in Iraq to protect troops from Iran-backed forces, pointing to rising tensions as Iran signals resumed attacks on U.S. troops.

Against this backdrop, investors are now closely watching global oil markets, anticipating a short-term spike in prices. This volatility is expected to persist until Hezbollah and Iran have retaliated, and the extent of the damage is assessed, BCA said. 

The firm notes that the current macroeconomic outlook supports this volatility, with weakening global demand as the U.S. economy slips, China’s lack of significant economic stimulus, and Europe on the brink of recession.

But the risk of oil supply shocks is also expected to rise after the U.S. election, regardless of the outcome, strategists said, “because Biden is a lame duck and will need to cement his legacy, which may involve disciplining Iran for betraying his trust, expanding its nuclear program, and attacking Israel and international shipping."

Beyond oil volatility, the Middle East escalation could impact markets by influencing the U.S. election. The situation, coupled with Russia's restriction of energy production and exports, could reinforce inflation or otherwise affect the ruling party.