What happens next in the Israel-Iran conflict: Four potential scenarios

The Israel-Iran conflict is a highly fluid situation with various potential geopolitical outcomes. Below, we outline four potential scenarios for how this conflict could evolve from here, followed by potential implications for the region’s oil and bond markets.

Four potential outcomes to the current conflict:

1. Controlled confrontation scenario
   In this scenario, both sides continue exchanging attacks without involvement from the U.S. or other external powers. The exchange of fire would likely diminish when Israel feels it has inflicted sufficient damage to Iran’s military capabilities, which could take several weeks or potentially several months. However, occasional exchanges of fire may persist beyond this period.
   
   Concerns would likely remain high around Iran trying to reconstitute its nuclear program. Even if Iran loses fire power and attacks become one-sided, Iran may endure the situation and attempt to find ways to respond and reconstitute. In this scenario, the impact of the conflict remains constrained to regional assets, but there are risks of collateral damage to oil facilities in the region or other targets. At this stage, this is the highest-probability scenario, in our view. 
2. Broader conflict involving the U.S.
   The U.S. has so far held back from directly intervening in the conflict. This could change if U.S. military assets in the region are attacked or if energy supply from the region is under threat. This is a significant downside risk that would likely have broader spillover to markets if it occurs. It’s also important to note that it is not guaranteed that U.S. involvement in the conflict would lead to a decisive end. At this stage, this is a medium‑probability scenario, in our view.
3. Iran steps back and approaches the U.S. with the aim to restart nuclear talks in earnest
   This could lead to the U.S. pressuring Israel into a ceasefire and resumption of nuclear negotiations. While this would be a constructive outcome, we assign a low probability to this playing out. That’s because, although Iran may be willing to agree to a ceasefire in exchange for nuclear talks, which would give it a break from the fighting and an opportunity to reconstitute, there is little incentive for Israel to accept such a deal. Ultimately, it would be difficult to see Iran agreeing to give up its nuclear capabilities and ballistic missiles, since this would be perceived internally as outright surrender to Israel.
4. Iran regime collapses
   At this stage, we assign a low probability to this outcome, with the caveat that political regime changes are difficult to predict.

Investment implications

Regional impact and oil

The Middle East will be affected to varying degrees by the conflict. A negative development for all would be if there’s any disruption to traffic in the Strait of Hormuz, which is a narrow waterway that enables the transport of roughly one-third of the world’s seaborne oil supplies.

In terms of oil, targets have so far been limited to domestic energy facilities; no exported oil barrels have been impacted yet. The United Arab Emirates and Saudi Arabia have capabilities to circumvent the Strait for a large share of their exports, but that is not the case for Iraq and Kuwait. The risks to the strait of Hormuz being blocked is limited, but shippers and insurers could be deterred from using the route, given the conflict.

Risks being underpriced

With risks skewed to the downside, regional bond markets in the Middle East are being too complacent, in our view. There is unlikely to be a resolution to the conflict in the near term. At current prices, we believe that investors are not being adequately compensated. For example, Israeli local government bonds and credit face increased geopolitical risk, potential deterioration of public finances, and higher funding needs.

Overall, the environment remains highly uncertain. We continue to monitor the evolving situation to evaluate implications for financial markets.