The market is still treating the closure of the Strait of Hormuz as a disruption that can be absorbed. That may prove correct, but the window for that outcome is narrowing.
The issue is no longer just the conflict itself. The fighting has eased, but the Strait remains effectively closed. Energy markets can absorb short disruptions through inventories, rerouted supply and strategic reserve releases. They cannot absorb an indefinite loss of one of the world’s most important energy transit routes without forcing a sharper adjustment in prices, demand or both.
For now, oil prices remain high, but not disorderly. Brent has been trading around $110 per barrel, which points to a tighter market, not a market in full crisis. That is the uncomfortable part. Prices are still close enough to baseline assumptions that investors can look through the disruption. Inventory data suggest that may be too comfortable.
Commercial oil inventories are being drawn down. The buffers that helped the market absorb the first phase of the shock are not permanent. A higher volume of oil already at sea helped cushion the initial supply loss. Strategic reserve releases have also offset part of the shock. China has helped as well, with crude imports falling as refiners reduced runs and stockpiling slowed. But these are bridges, not foundations.
If inventories are still falling, demand is still exceeding available supply.
Inventories are the transmission path
The market debate has focused heavily on oil prices. That is understandable. Prices are visible.
They move every day. They shape the headlines.
But prices are the outcome. Inventories are the transmission path.
If OECD commercial oil inventories continue to decline at the pace seen in April, they could reach critically low levels by the end of June. Based on the historical relationship between inventories and Brent, a further monthly drawdown of roughly 100 million barrels over the next couple of months would be consistent with Brent averaging $130 to $140 per barrel in June, with the possibility of prices moving even higher.
That is why the adverse scenario should now be assessed in weeks, not months. Markets can tolerate disruption when there is confidence that supply will normalize before inventories become scarce. It becomes a different environment when the inventory cushion is being depleted and the political path to reopening remains unclear. At that point, prices may no longer move in a smooth line. Demand destruction becomes a more likely adjustment mechanism.
That is the risk investors should be watching. Not simply whether oil trades at $110, $120 or $130 per barrel, but whether the market begins to conclude that supply will not normalize before inventories reach stressed levels.
The political constraint has become the market constraint
The economic issue is being driven by a political impasse.
Iran appears to view control over the Strait as one of its few remaining sources of leverage. The U.S. appears unwilling to accept a deal that does not include meaningful constraints on Iran’s nuclear programme. A quick reopening remains possible, but it is becoming harder to assume.
That gap is becoming harder to ignore. Energy prices are elevated but still appear to embed some probability that the Strait reopens relatively soon. The futures curve also suggests that supply conditions are expected to improve later this year. If that improvement does not materialize, prices may have to adjust quickly.
The political path has become more complicated, while the market still appears to be leaning on the idea that the disruption resolves before the inventory problem becomes binding. That may be too comfortable.
Markets look calm, but not clean
That same discomfort is visible in equities, although not in the headline index.
U.S. equity indices remain close to all-time highs, and volatility measures have largely retraced their early war moves. On the surface, that looks like resilience. Beneath the surface, the message is less settled.
The rally has again been supported by AI enthusiasm, but that strength has not been evenly distributed. Median stock drawdowns have been larger than the headline index implies, dispersion within the NASDAQ 100 has risen sharply, and the unusual co-movement between the VIX and the S&P 500 suggests investors may be chasing upside while still paying for downside protection.
That does not mean the rally is about to break, but it does suggest investors are less comfortable than the index level implies.
This matters because markets often look calm at the index level until the transmission path begins to matter. The same pattern is visible here. Headline equities are being supported by a narrow and powerful narrative. Energy inventories are moving in the other direction.
If the Strait remains closed, the inventory signal deserves more weight than headline index resilience.
The growth risk is not yet fully priced
The first phase of the shock has been inflationary. Headline inflation has already moved higher across several advanced economies. Core inflation has been more contained, but short-term inflation expectations among households and firms have risen.
So far, the growth damage has been limited. Real spending has not contracted meaningfully. Labour markets have held up reasonably well. That is why investors have been able to keep treating the shock as manageable.
But that is not the same as resilience.
Consumer confidence has weakened. Hiring intentions have softened. Industrial production has declined in several major economies, partly due to weakness in energy-intensive production. The early damage is visible, even if it has not yet become the dominant market narrative.
The inflation path also matters because the shock does not stop at gasoline. The first-round effect has already appeared in fuel prices. The next phase is the pass-through into transport, food, hospitality and other energy-sensitive categories. Higher fertiliser prices add another channel into food inflation. Foodstuff commodity prices have also moved higher since February.
That does not mean a repeat of 2022 is inevitable. Demand is softer, labour markets are less tight, and policy rates are already much closer to neutral or restrictive. Those conditions reduce the risk that second-round effects become entrenched. But the longer the Strait remains closed, the more central banks will worry that a relative price shock is becoming an inflation expectations problem.
Central banks cannot produce more oil. They cannot reopen the Strait. But they may still feel compelled to respond if higher energy prices begin to feed into inflation expectations. That is where the policy trade-off becomes much harder.
What the adverse scenario could look like
A more adverse scenario does not require the most extreme assumptions to become damaging.
In the adverse scenario we are monitoring, global oil exports decline by nearly 10% this year, while liquefied natural gas exports fall by more than 10%. Brent rises to roughly $130 per barrel at the start of the third quarter, before gradually falling back toward $120 by year end. The economic damage would be materially larger than in the baseline, and it is unlikely to be linear. Once energy prices rise far enough, behaviour changes. Households pull back. Businesses delay spending. Governments reassess subsidies. Central banks become less comfortable looking through the shock.
The adverse scenario would not simply be a higher oil price scenario. It would be a stagflation scenario. In our baseline scenario, global growth slows but remains positive. In the adverse case, the combination of persistent energy shortages, higher inflation, weaker real income and tighter policy could be enough to push the world economy into recession.
Asia and Europe would likely be more vulnerable than the U.S. because they are larger net energy importers. China may initially benefit from demand for green technology exports, but if global energy prices rise far enough, consumers who were considering electric vehicles or solar panels may simply reduce spending more broadly. Europe faces a similar challenge through imported energy costs and tighter financial conditions.
The policy response would be uncomfortable. Central banks cannot lower energy prices, but they can respond if higher energy prices begin to lift inflation expectations. That creates the risk of insurance hikes into a weakening growth backdrop. Europe is one of the clearest examples. The ECB may be able to justify modest hikes as a signal that it will not tolerate second-round inflation, but in a prolonged closure, that message would come with a higher risk of policy tightening into a slowdown.
That is the point where the shock stops being only about energy and starts becoming about financial conditions.
Canada’s offset is real, but incomplete
Canada sits in a more complicated position than many other developed economies.
Higher oil prices can support national income, production and exports, which provides a partial offset that Europe and much of Asia do not have. Canada is not simply importing the shock. There is a terms-of-trade benefit that can support parts of the economy and improve the fiscal backdrop.
But households feel the shock first through gasoline, transportation costs, mortgage rates and confidence. Consumer confidence has already deteriorated, retail spending is at risk of losing momentum, and headline inflation is expected to rebound toward 3%.
The Bank of Canada will be watching whether higher energy prices begin to affect selling price expectations, core inflation and longer-run household inflation expectations. In the baseline, weak underlying activity and limited evidence of entrenched second-round effects still support patience. In a more adverse scenario, where oil remains above $100 and core inflation risks rise, it becomes harder for the Bank of Canada to stay on the sidelines.
For Canada, the offset is real, but uneven. It is slower, harder to see in household cash flow, and more dependent on how higher energy income moves through corporate investment, government revenues and labour markets.
Canada Life Investment Management Portfolio positioning
Our positioning continues to reflect the view that this is a transmission shock, not simply a geopolitical headline.
We have maintained a focus on diversification, liquidity and resilience. That means avoiding the temptation to position portfolios around a single outcome. A reopening of the Strait would likely bring relief in energy prices and risk assets. A prolonged closure would be a very different environment, with inflation risk, growth risk and policy risk reinforcing one another.
In our portfolios, balance remains important. Equity exposure continues to have a role, particularly where the underlying mandates emphasize earnings quality, cash flow durability and structural growth. But we have continued to place greater emphasis on selectivity when energy costs are rising, margins may come under pressure and headline indices are being supported by a narrower set of companies.
We view duration as a more conditional source of protection in this environment. It can help if growth risks dominate, but it is less reliable if central banks are forced to respond to another inflation shock. That does not remove the role of fixed income. It does mean the path matters.
Our positioning reflects that reality. We continue to use liquid alternatives, less correlated strategies, diversified fixed income, quality-oriented equity mandates and disciplined regional allocation to reduce dependence on any single macro outcome.
The objective is not to predict the next headline out of the Gulf. It is to keep portfolios from becoming overly dependent on a benign resolution.
The question is no longer whether the Strait matters. It is how much time markets have before the inventory cushion becomes thin enough to force a sharper adjustment. Based on current inventory dynamics, that answer may be weeks.
Sincerely,
Corrado Tiralongo (he/him)
Vice President, Asset Allocation & Chief Investment Officer
Canada Life Investment Management Ltd.
The views expressed in this commentary are those of Canada Life Investment Management Ltd. as at the date of publication and are subject to change without notice. This commentary is presented only as a general source of information and is not intended as a solicitation to buy or sell specific investments, nor is it intended to provide tax or legal advice. Prospective investors should review the offering documents relating to any investment carefully before making an investment decision and should ask their financial security advisor for advice based on their specific circumstances.
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