The US-Iran agreement stabilises oil markets and diminishes the chances of recession

Traders noticed this new development as a signal that the worst of the crisis may have passed. It led to a sharp drop in oil prices

The recent US-Iran agreement has helped reassure people about their oil resources. It removed a major reason for a global economic recession. Even as the agreement has done much to soothe nerves and reduce risk premiums, experts caution that it is not a panacea for an economy facing the challenge of sluggish growth amid ongoing geopolitical risks.

The reaction from the markets was positive, with Brent crude oil declining sharply as investors trimmed their estimates of supply problems. Stocks moved higher around the world, while volatility indicators decreased because the possibility of an energy crisis was no longer considered.

The Strait of Hormuz, through which one-fifth of the world’s oil supply flows, has been at the heart of worries about markets after tensions began to mount earlier this year. Any type of disruption in traffic passing through the waterway could impact energy supplies around the world.

In the opinion of Oxford Economics, the deal marks a significant diplomatic breakthrough and a promising step toward further settlement, although many difficulties lie ahead. “While it is an important step towards the conclusion of a full-fledged deal, there are still going to be some hurdles along the way,” commented Ben May, Global Macro Research Director at Oxford Economics.

He believes that the major impact of this news is the decreased probability of an extreme supply shock from the oil industry, as opposed to any actual increase in oil flows. Oxford Economics had already factored into its June baseline projection that the flow of oil through the Strait of Hormuz would start recovering from late July onwards. This means that this new development does not automatically imply an accelerated flow of oil as expected before.

The difference lies in the risk ratio.

Prior to the deal, economists expressed fears that long-term disruption in oil supplies might lead to a drop in the world’s oil reserves, which would lead to a growth in prices and, therefore, cause new inflationary pressures on economies experiencing slow growth and high borrowing rates.

“The fact that both sides have agreed already has reduced tail risks of declining oil stocks leading to an economic recession due to a sharp oil price rise,” said May.

According to Bridget Payne, Head of Oil & Gas Forecasting at Oxford Economics, “reduced geopolitical tensions have materially improved the energy market outlook,” as mentioned in Khaleej Times.

Even though shipping volumes will continue to take some time to recover to the pre-conflict stage, the possibility of an acute inventory shortage has been significantly reduced. Hence, Oxford Economics is likely to revise its forecast of crude oil prices downwards in its next report.

Market reactions in energy suggest that investors agree with the assessment. The price of Brent crude dropped by approximately 5 per cent following reports on the deal, indicating increasing optimism that the least desirable scenario is unlikely to materialise for the global oil market.

This is also the conclusion drawn by independent analysts.

The Reuters news agency noted that the progress was seen as an indication that the worst is over with regard to the crisis and helped oil prices drop to their lowest in several months. The expectation now is for the flow of energy resources via the Strait of Hormuz to become normalised.

Experts have warned, however, that it will take some time for things to get back to normal.

Various shipping lines, tankers and marine insurance organisations have stated that ships are still restricted due to issues of security, mine clearance and insurance premiums. Various shipping firms have stated that they will gradually resume normal activities once they confirm the safety situation. Industry experts predict that it may take several months for the shipping industry to return to its pre-conflict level.

This perspective is consistent with the assessment by Oxford Economics that the deal does not automatically lead to a swift boost in oil shipments. Although the markets are optimistic, the implementation of maritime trade itself is no easy feat.

The geopolitical community has also sounded a note of caution. Various experts have termed the agreement as significant progress, but stressed that the accord is only a framework deal and not a total settlement. Many challenging negotiations need to be held on the issues of sanctions, security guarantees, and outstanding matters related to the Iranian nuclear programme.

These are among the reasons why economists are not very confident about the broader economic effects.

The drop in oil prices is expected to have an impact on inflation levels in many developed countries. Individuals and firms will glimpse some relief from declining fuel costs amid volatility in energy markets.

Nonetheless, according to Oxford Economics, the subsequent effect on economic growth will be small.

The consultancy remains of the view that the world economy will grow in 2026 within the relatively predictable range of 2.8 per cent and 3.0 per cent seen in the last few years. Although the low cost of energy will help, it will not be able to solve the structural problems facing the growth process, which include a lack of investment, poor productivity, and conservative consumption.

In effect, the deal takes away a key negative element while leaving the path of the global economy intact.

The implications for central banks could become more important than the effect on growth itself.

According to Oxford Economics, lower oil prices made them even more convinced of their long-standing assumption that the Federal Reserve in the United States and the Bank of England will not consider raising interest rates any further. Moreover, the lowered threat of oil-induced inflation will make it less likely that the aforementioned central banks will be forced to tighten their policy positions once again.

It would seem that financial markets hold similar sentiments as well. The decline in crude oil prices has been a reason for falling inflation expectations, and policymakers will also need to deal with another rise in consumer prices due to energy.

The agreement serves to eliminate an element of uncertainty for policymakers. Investors will benefit from a reduced risk of future inflation shocks. Consumers stand to gain from lower energy prices.

Nevertheless, the general conclusion of economists is quite clear: the accord mitigates a significant negative factor, but it does not generate a strong new force for the world economy.

While the global economy may now be less vulnerable to an oil crisis, it certainly has its hands full with a very difficult combination of low demand, geopolitical risks, and mixed growth momentum. The US-Iran agreement is certainly positive for markets and policymakers; however, it is not a game-changer for the global economy.