The invisible hand pushing for peace?

Markets are reacting positively to improving prospects of peace being restored to the Persian Gulf region. Crude oil prices continue to fall on hopes of new US-Iran peace talks, and stock prices are recovering toward their pre-conflict levels. Financial markets, on their part, provide feedback to policymakers that can influence outcomes. Extended market losses provide markers for economic consequences of strategic decisions like war - and the road to peace. Yet, markets can sometimes get ahead of events, and their reliability as a signalling tool is questionable. The assumption that prices reflect all available information does not always hold.

Crude prices are declining because oil traders are betting on an imminent conclusion to the crisis. Yet, disruptions in energy supplies will begin to show up now as consuming nations draw down their strategic reserves. Recovery in headline equity indices may not factor in the delayed inflationary impact of a broken global plastic supply chain, or the effects of a urea shock to the global food supply. These are typically second-order effects, acting with a lag. But they tend to attach a long tail to an energy shock. By itself, energy has a strong correlation with economic activity, therefore, supplies affected by war, and post-war restoration of oil wells and gas fields will have a bearing on global economic growth and average inflation levels. Merchandise trade will bear the impact, even as it adjusts to a new tariff regime imposed by the world's biggest importer, the US.

Role of markets in influencing decisions over conflict is profound and has been used by belligerents routinely. Iran has jeopardised its relations with its energy-exporting neighbours in the region through attacks on energy infrastructure and closure of the Strait of Hormuz. The domino effect on financial markets, it can be argued, hastened the peace process. US and Iranian negotiators will keep this market feedback in mind when they meet again to discuss an enduring cessation of hostilities.