Disagreements and Developments in the Middle East Conflict

The trajectory of the Iran conflict and its market impact are subject to significant divergent expectations. Behind these differing judgments are three core issues that currently cannot be verified, making answers elusive: First, after the conflict intensity decreases, to what extent can maritime navigation resume? Second, does the Federal Reserve prioritize inflation indicators or focus more on actual employment conditions? Third, is China facing a cost shock or an opportunity for supply chain reallocation? These questions may only become clearer by April.

In the face of great uncertainty, the market has seen some short-term trimming of positions, with previously strong-performing assets recently experiencing notable declines. Overall, most performance-driven and narrative-driven market signals have returned to a similar starting point since the beginning of the year. The first three months can be viewed as a market rotation driven by expectations and narrative battles during the spring surge and cooling period, not the definitive trend for the whole year. The broader rebound in PPI, price transmission, and corporate profit recovery are the directions with both expectation gaps and room for growth this year, but the key decisions will depend on April.

Divergent Expectations on the Iran Conflict and Market Impact

1) “Decreased conflict intensity, timely TACO” vs. “Maritime navigation not yet restored, supply chain disruptions not fully reflected in supply.”

First view: Since the outbreak on February 28, 2026, the US and Israel have carried out targeted high-level eliminations of at least 22 key military and political figures, including top leaders, Revolutionary Guard commanders, chief of staff, defense minister, intelligence minister, NSC secretary, and Baski commanders. This indicates a significant blow to Iran’s central command, intelligence, and military-political coordination. The view holds that major upheavals are unlikely to follow, and if Trump halts actions timely and withdraws quickly, TACO transactions could still proceed.

Second view: The Iran conflict is highly unpredictable. Unless maritime traffic normalizes, marginal trading changes could be disrupted by new shocks at any time. Currently, maritime traffic has not recovered; as of March 19, 2026, the number of oil tankers passing through the Strait of Hormuz remains in the low single digits per day.

Additionally, the current spread between Brent crude and Dubai/Oman spot prices is large, possibly due to regional inventory buffers, pricing structure deviations, or policy interventions. If the Strait remains closed, prices are likely to revert toward Middle Eastern spot levels.

2) “Clear risk of stagflation, liquidity tightening” vs. “Employment prospects more affected by AI, making tightening difficult.”

First view: Historical experience with major Middle East conflicts and supply shocks suggests that even if stagflation does not develop, cost-push inflation could delay Fed rate cuts. This would pose a significant challenge to liquidity. After the March 18 Fed meeting, implied rate cuts in the CME FedWatch tool remain at 0-1 times this year.

Second view: AI infrastructure investments will continue, and post-conflict, countries will accelerate electrification and energy supply chain security (e.g., recent UK easing wind power component tariffs). Overall industrial demand remains strong, and the probability of a global slowdown is low. However, AI agents—powerful productivity tools—are already impacting employment. The maturity of coding agents in February marked a critical point, but the full employment impact is still unclear. Meanwhile, layoffs at major tech firms are increasing. These factors make Fed tightening less likely solely due to energy cost shocks.

3) “Prolonged conflict would significantly impact China” vs. “China’s supply chain resilience is strong, with reduced oil dependency.”

First view: China’s high reliance on oil imports, especially from the Middle East—about 36% of total crude imports in 2025—means ongoing conflict would heavily impact energy costs. Many Asia-Pacific countries face similar issues, while the US is largely self-sufficient in oil and resources.

Second view: Looking at the ratio of oil imports to GDP, China’s dependence has decreased from 2.2% fifteen years ago to about 1.7% (around $80 per barrel in 2010 and 2024). Current domestic inventories, including strategic reserves, can cover over 90 days of consumption. China’s energy substitution options—such as coal chemical and green alcohol routes—still have excess capacity and space for wind and solar integration, potentially replacing some oil demand.

More importantly, China has long-term energy diversification strategies. According to the “2025 Domestic and International Oil & Gas Industry Development Report,” additional supply from Russia, the Americas, Africa, Central Asia, and neighboring regions could add about 130 million tons annually. Coupled with domestic production potential of 20 million tons and strategic reserves, total substitution capacity could reach approximately 180 million tons per year—covering the Strait of Hormuz risk exposure of about 185 million tons. A more likely scenario is supply chain disruptions in Europe, Japan, and India, which could shift demand toward China, accelerating the alleviation of China’s own overcapacity issues in energy chemicals, similar to post-pandemic supply chain shifts.

Core Unverifiable Questions Entering April

1) After conflict intensity decreases, to what extent can maritime navigation resume?

As of March 19, only five ships (four small bulk carriers and one refined oil tanker) have transited the Strait of Hormuz daily, with no signs of large-scale resumption (pre-conflict daily averages of 120–140 ships). The blockade has lasted 20 days, with about 20,000 seafarers stranded on Persian Gulf vessels. Navigation now shows significant “camping” features, with only certain ship registries permitted through specific mechanisms. According to LSEG, VLCC (Very Large Crude Carriers) daily charter rates have surged from $10–20/ton to $60–80/ton, with some periods exceeding $90/ton, reaching historical highs.

Lloyd’s List reports Iran has established “safe corridors” within its territorial waters, implementing conditional paid passage mechanisms. Ships must report owner info, cargo destination, etc., and undergo Iranian verification. Some oil companies have paid around $2 million for passage rights. Currently, over 70% of ships transiting are from China, Russia, and Iran, with the rest from Panama, Tanzania, Singapore, and other neutral flags. No ships from the US, Israel, or European countries are reported transiting.

2) Does the Fed prioritize inflation indicators or employment data?

The Fed’s March 2026 meeting kept rates steady at 3.50–3.75%, maintaining a hawkish stance as expected. Powell’s “wait and see” approach reflects uncertainty about the scale and duration of shocks, noting that traditional views often “look through” energy shocks. Currently, TIPS implied inflation expectations for five years have only risen about 23 basis points; considering liquidity impacts, five-year inflation expectations are nearly unchanged. Employment data shows signs of slowdown: February non-farm payrolls contracted, and December 2025 and January 2026 figures were significantly revised downward. The Fed’s latest SEP removed language about “signs of stabilization” in unemployment, indicating concern over ongoing employment weakness.

Additionally, the capabilities of coding agents like Opus 4.6 and GPT 5.3 Codex, launched in early February, are still evolving. The impact on employment—especially at large firms—is uncertain, though layoffs are increasing. These factors complicate the Fed’s policy stance, which remains cautious and data-dependent.

3) Is China facing a cost shock or an opportunity for supply chain reallocation?

High-frequency data show initial transmission of price signals from spot to futures markets. Logically, supply shocks tend to boost profit margins in the most resilient segments of the supply chain, and China’s supply chain remains relatively robust. However, the core issue is “price inaction”—the market’s “no-trade” environment—meaning it’s not yet the right time for contrarian positioning. Downstream manufacturers, facing high volatility, are cautious about restocking, waiting for stability. As long as inventories are not exhausted, the market is likely observing the conflict’s development, waiting for stabilization. Therefore, the industry’s profit expectations are based on prices after the conflict stabilizes and volatility subsides, explaining the divergence between stock and futures/spot prices.

Until commodity volatility decreases, the market remains driven by narratives and liquidity shocks. Price signals may fluctuate frequently, and market participants might even engage in forward-looking narrative battles.

Short-term Market Adjustments and Recent Declines

Since March, the decline in certain sectors and the positioning of relative-return funds do not align. The top four sectors held by institutions have fallen an average of 5.6% since March, with electric power and communications sectors posting positive returns, while the sectors with the lowest institutional allocation have fallen an average of 8.9%. This suggests that the main driver of volatility is not institutional rebalancing but rather absolute return funds reducing positions.

At the style level, low-valuation stocks are safer, while high-valuation stocks have fallen more sharply. On the stock level, stocks that rose more in the past two months have experienced larger declines, consistent with absolute return fund de-risking. In a phase where valuation levels are high, profit margins have yet to materialize, and macro uncertainties increase, de-risking by absolute return funds is rational.

In this environment, fundamentals give way to liquidity and narrative factors. Stocks that surged on narrative in January–February have seen more intense corrections in March. This is normal; no need to over-interpret the price movements.

Back to the Starting Line: Key Decisions in April

1) Core uncertainties about the Middle East conflict will gradually be clarified after April.

The key market questions outlined earlier will see answers emerge in April. Until then, markets will remain in a narrative battle, reflecting liquidity withdrawal. US Treasury yields continue to rise sharply, with the 10-year yield climbing from 3.97% at the end of February to 4.39%, the highest since August last year. Globally, as risk sentiment recovers, countries are strengthening energy and resource security and accelerating electrification. China’s manufacturing competitiveness in pricing and profit margins is just beginning to shift.

From a trading perspective, rising prices and PPI rebound are ongoing signals. The main concern is upstream prices’ difficulty in passing through downstream. Currently, upstream and midstream sectors are raising prices, while downstream remains cautious and inventory-digesting. Only over time, as volatility subsides, will downstream procurement normalize. Whether downstream can maintain price increases, sustain profit margins, and convert market share into pricing power remains to be seen. Until then, patience and calm are advised. April–May will be the decisive period. Even if early narrative-driven sector rotations do not yield gains, it’s not a major issue; the median return of active equity funds has already reached 0.7% this year.

2) Focus on re-estimating China’s manufacturing pricing power.

The current core holdings should be sectors with China’s market share advantage, high barriers to overseas capacity reconfiguration, and supply flexibility influenced by policy—namely new energy, chemicals, electrical equipment, and non-ferrous metals. Recent liquidity shocks have brought valuations back to attractive levels, similar to the post-April 7, 2022, offshore stock surge, creating significant expectations gaps and undervaluation.

Based on this foundation, increasing exposure to low-valuation factors—particularly insurance, securities, and power—is recommended. Short-term signals suggest that price increases remain the “sharpest sword,” and the probability of PPI-driven themes dominating the year is rising. April–May will be critical for decision-making.

Several structural opportunities are worth monitoring: 1) chemical products with alternative raw materials/process routes under oil price shocks (China’s “coal content” often higher than overseas competitors); 2) supply disruptions in previously dominant Middle Eastern/Western European capacity could create supply-demand gaps and price increases; 3) demand-driven price hikes in substitution products affected by costs; 4) supply-demand balance in commodities already in an upward price channel, with cost increases providing a window for price pass-through.

Risks

• Escalation of US-China tech, trade, and financial frictions
• Domestic policy implementation or economic recovery falling short
• Excessive tightening of global liquidity
• Further escalation of conflicts in Ukraine, Middle East, etc.
• China’s real estate inventory digestion underperforming expectations

Source: CITIC Securities Research

Risk Disclaimer

Market risks exist; investments should be cautious. This article does not constitute personal investment advice and does not consider individual user’s specific investment goals, financial situation, or needs. Users should evaluate whether the opinions, views, or conclusions herein are suitable for their circumstances. Investment is at their own risk.