Iran: What Length For War?

The Israel and U.S. attack on Iran appears designed at regime change.  How long will the war last and what will be the global macroeconomic impact?   

Figure 1: Brent Oil Prices (USD)     

Source: Refinitiv  

A number of points are worth considering on the length of the war between Israel/U.S. and Iran.

·       Oil and gas supply.  The jump in oil and gas prices has so far been modest, despite the effective closure of the straits of Hormuz by Iran.  Part of this is OPEC+ immediate increase of 200k barrels per day signalling that further supply could be added if the war drags on.  However, the modest reaction also reflects anticipation that the war will likely be short, with the U.S. and Israel attacking many military targets in Iran.  Though Iran is attacking U.S. military bases and civilian targets throughout the region, financial markets appear to be anticipating that this will be subdued by U.S. and Israel military forces in the next few days and potentially defensive activity by gulf nations.   

·       Focus of regime change.  While financial markets had feared a limited U.S. attack to soften up Iran nuclear negotiations, statements from President Trump and others suggests that regime change is on the agenda.  The immediate focus is on the appointment of a new Supreme leader in the next couple of days and whether that led to a ceasefire and negotiations with the U.S..  Trump hinted at this off ramp on Sunday evening.  However, this could led to a ceasefire but may not led to a lasting settlement, if the U.S./Israel demands are too far reaching e.g. free elections.  The Iranian military do not want a path towards free elections and could prefer to seize power and change decision making in Iran between the clerics and the military that would still leave an autocratic government.  This could leave Israel and the U.S. either continuing military activity for weeks or threatening to restart hostilities.

·       Trump changing objectives.  One off ramp is Trump changing objectives of the war with Iran.  While he has indicated that this is about regime change, Trump has changed goals in the past and could decide later this week to declare victory with the death of the Supreme leader and the military airstrikes success.  Trump will be under domestic voter pressure from the increase in oil prices, which would intensify the higher that oil prices go.  Trump is also facing some political pressure for not preparing the U.S. for the war with Iran, though this is modest rather than intense pressure. 

Macro impact.  If the war is short and leads to a ceasefire then the global economic impact will be small, with the greatest impact in the middle east of oil/gas supplies on a temporary basis and tourism.  If the war is more prolonged then oil/gas supplies could be squeezed more and OPEC+ only partially making up the difference.  This 2nd scenario would have a modest adverse impact on growth and inflation.  For now we tend to see a shorter war, partially as Trump could change goals and declare victory.