Stocks Tumble and Dollar Strengthens as Iran Conflict Ignites Energy Crisis and Fears of Global Stagflation

A selloff in stocks deepened on Tuesday and the dollar strengthened as investors considered the implications of U.S. and Israeli strikes on Iran on energy prices and the global economy.

MSCI's broadest index of Asia-Pacific shares outside Japan fell 1.5% to extend losses for a second day, led by a drop of as much as 4.1% in Korean shares. Tokyo's Nikkei 225 slumped 2.3% and S&P 500 e-mini futures were down 0.6%.

"Economic policy uncertainty was already elevated and now with the Iran conflict, the geopolitical risk is expected to rise too," said Rupal Agarwal, Asia quant strategist at Bernstein in Singapore. "Last time both spiked was in 2022 during the Russia-Ukraine conflict, which didn’t work well for Asian markets."

Wall Street stabilised after a volatile session on Monday which saw the S&P 500 rally from an early selloff to close flat and the Nasdaq Composite climb 0.4% as investors bought the dip in markets.

U.S. President Donald Trump sought to justify a broad, open-ended war on Iran, saying on Monday the campaign was ahead of expectations.

With no end to hostilities in sight, an official from Iran's Revolutionary Guards said on Monday that the Strait of Hormuz is closed to marine traffic and the country will fire on any ship trying to pass.

The threat had an immediate impact, pushing the cost of hiring a supertanker to ship oil from the Middle East to China to a record high of more than $400,000 a day, LSEG data showed.

After oil and gas prices surged on Monday, Brent crude futures tacked on another 2% to $79.22 on Tuesday. In natural gas markets, benchmark European and Asian LNG prices leapt by around 40% on Monday.

WORKING THROUGH THE RISK SCENARIOS

The spike in energy prices could ramp up costs for Asian companies and weigh on their profits and their stocks, which have rallied sharply so far this year.

"We estimate a 20% rise in Brent could reduce regional earnings by 2% with wide intraregional variation, but this depends on the duration of the conflict," analysts from Goldman Sachs wrote in a research report. "Spikes in geopolitical risk tend to have a negative short-term effect but dissipate over time," they said. "The current rise in geopolitical risk coincides with regional vulnerability to a correction."

The surge in energy prices complicates the Federal Reserve's efforts to keep inflation under control, with policymakers already showing signs of division around the impact of artificial intelligence on the U.S. economy. The U.S. will take action to mitigate rising energy prices due to a spike in the price of oil caused by the Iran conflict, Secretary of State Rubio said on Monday.

ISM manufacturing data released Monday showed U.S. activity grew steadily in February, but a gauge of factory gate prices raced to a near 3-1/2-year high amid tariffs, highlighting upside pressure on inflation even before the U.S.-led attacks on Iran.

Fed funds futures are pricing an implied 97.5% probability that the U.S. central bank will remain on hold at the end of its next two-day meeting on March 18, according to the CME Group's FedWatch tool. The odds of a June hold, previously below 50%, edged up on Monday and are now slightly better than a coin-toss.

The U.S. dollar index, which measures the greenback's strength against a basket of six major peers, held close to a six-week high at 98.499 as the currency regained some of its allure as a safe haven. The yield on the U.S. 10-year Treasury bond was last down 1.2 basis points at 4.036%.

"Current market dynamics are only showing a mild risk-off tone, insufficient to sustain a firm bid in U.S. Treasury bonds or to nudge the Fed into quicker cuts," analysts from DBS wrote in a research note.

"However, the conflict does raise the spectre of stagflation," they added. "While energy prices are nowhere close to the levels seen during the start of the Russia-Ukraine conflict in 2022, investors will probably be keeping a close eye on the extent and duration that energy supplies will be disrupted."

Gold edged up 0.6% at $5,358.44. Bitcoin slumped 1.5% to $68,399.26, while ether was down 1.5% at $2,013.07. 

Also read: Strait of Hormuz Crisis: What Does It Mean For Global Economy & India?