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On May 6th, BMO hosted a digital event to explore how equity markets, FX, and macro data are considering evolving geopolitical risks, pricing in potential outcomes while downplaying others. The discussion centered on market signals, cross-asset linkages, and what financial conditions are telling us about growth, risk appetite, and resilience. Let's listen in.
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Welcome to Markets Plus, where leading experts from across BMO discuss factors shaping the markets, economy, industry sectors, and much more. Visit bmocm.com/marketsplus for more episodes.
Mike Miranda:
Good afternoon, everyone, and welcome. I'm Mike Miranda, president of BMO Family Office and head of investments for BMO Wealth Management. Thank you for joining us for today's digital event, Middle East Conflict: Reading Market Signals About Risk. This conversation is part of our ongoing effort to help clients and colleagues navigate geopolitical uncertainty, and critically, to interpret what financial markets are actually telling us about risk.
To set the stage, this conflict has had a clear impact on oil prices, which have experienced significant volatility as markets repeatedly reassess the risk of physical supply disruptions. Energy has been the most direct and visible transmission channel for geopolitical risk. At the same time, broader asset markets have remained resilient, and in several areas, have reached new highs. That resilience suggests investors are increasingly looking through near-term conflict dynamics and anchoring to fundamentals, including economic momentum and strong investment themes such as AI. Interest rates have remained relatively contained, even as central banks assess how geopolitical developments, particularly through energy, could affect inflation. That tension between heightened headline risk and underlying fundamental strength is exactly what we want to unpack today by reading market signals across asset class.
Joining me today are three BMO experts, Randy Ollenberger, managing director of oil and gas research within BMO Capital Markets, Doug Porter, managing director and chief economist at BMO, Katherine Krantz, managing director of portfolio strategy at BMO Capital Markets. Thank you all for being here. So Randy, let's start with you first. Can you talk about how the fragile geopolitical situation between the US and Iran continues to affect energy markets as the situation with the Strait of Hormuz remains tense? And from your perspective, what is next?
Randy Ollenberger:
Yeah. Thanks, Michael. And fragile is the right word. It is fragile. I mean, we've seen this go on a stop-start basis for the last month or so after the initial fusillade of attacks that we saw through March. Today, for example, we're seeing a pause as the market hopes that Trump and Iran could come to some sort of agreement. But even if they do, there's a couple of things that I think investors need to keep in mind.
One is it will take time to normalize flows. And by time, I mean, two to three months before we'd expect to see more normalized flows, and perhaps up to six months before we see production levels and transport levels restored to where they were prior to the conflict. The second is there's likely to be disagreements as they negotiate the outcome here. And so, we're likely to experience periods where Iran disagrees with something that they're negotiating, or the United States disagrees, and then there's the threat of hostilities escalating again. So there are still a lot of risks. Those risks, I would say, still tend to be biased to the upside, and so we still expect a lot of volatility over the coming months.
Mike Miranda:
All right. Thanks for that, Randy. Last week, the UAE announced that it would exit OPEC. What are the wider implications, from your perspective?
Randy Ollenberger:
Yeah, no. So if we were in a normal oil market, this would've been a clear negative event, and it's been something that's actually been overhanging the oil market for the last five years or so as the UAE has wanted to increase production levels. As we sit here today, obviously, it's less relevant. We've got no oil coming out of the Persian Gulf, and so it's not really a threat.
But even coming out of this, we're going to be in a different world. We're going to be in a world where there's not a lot of spare capacity. So the Saudis probably would have about a million barrels a day of spare capacity. In the UAE, about 500,000 barrels a day of spare capacity. So coming out of this, there's not a lot of spare capacity that could lead to a price war. And secondly, we're likely to see countries now try to increase strategic stockpiles. So that means higher oil demand coming out of this, and so we actually may need those barrels out of the UAE. So it is a bit negative for the oil market overall, but I don't think it's anywhere near as negative as it would've been a couple of years ago.
Mike Miranda:
All right. Thanks for that. Doug, let's bring you into the conversation. When the war first launched, you and your team laid out the possible scenarios for the economy. Where are we with those scenarios, and how have we had to pivot?
Doug Porter:
Yeah. Thanks, Mike. Well, when we think back to the very earliest days, I have to say, we laid out four possible scenarios. And I would say, based on the facts on the ground in terms of how much oil has actually been kept out of the market, for how long, that's turned towards, I would say, the most pessimistic of our four scenarios. The way we've had to pivot, of course, is considered a different set of possible circumstances in terms of how long this will drag on for, which clearly it's much longer than the two-month maximum we initially set out.
But I have to say, and this goes back to something that Randy said, I think the surprise here has been just how well-behaved oil prices have been overall, given the amount of physical oil that's been removed from the market. To me, it's not a surprise that the markets have been able to manage $100 oil and the economy has managed to hang in there on $100 oil. Look, when you think back 10, 15 years ago, we had a long period, a long stretch where the global economy had to deal with oil prices over $100 a barrel of oil for quite an extended period of time, so that part is not new.
I think, I personally believe that the big surprise here is that we're still talking about roughly $100 oil when so much oil has been physically removed. The only assumption must be that the market is absolutely convinced that, one way or other, this will not last that much longer and that supplies will reopen. And even if it does take time to get back to normal, as Randy suggested, we're not looking at prices of $130, $150, which would create real problems for the global economy.
It's interesting that even though, as I said, it's tended towards our most pessimistic view in terms of physical oil supplies, in fact, in actual oil pricing terms, it's actually hit our assumption fairly closely. We were looking at something on the order of $95 to $100 barrel average through April, May, and possibly June, and that still looks very reasonable. So the very brief answer to your question is we really haven't changed our economic forecast that much from the opening days of the conflict.
Mike Miranda:
Yeah. Well, thanks for that, Doug. We hear from clients often concern about the economic backdrop. One question I think that we get is, how long before something like this leads to a full-on recession in the US, and by extension, Canada? How are you thinking about that specific risk today?
Doug Porter:
Yeah. And again, I would stress the fact that because Canada and the US are oil exporters, there are certainly buffers to those economies. Regions of the economy, sectors of the economy do perform relatively well, offsetting the, or at least partially offsetting the direct hit to consumers and industries that are more oil buyers than sellers. And the overall view is that for Canada and the US, a rise in oil prices can be seen as a neutral, if not even a small positive in the case of Canada.
Having said that, when you do get hit with an oil shock, the benefits to producers are simply swamped by the negative to consumers if oil prices rise high enough. I don't think we're to that point yet, but we do still view it as a... Because it has erupted so suddenly and it is such a weight on consumers, we believe that it is a short-term negative for both economies. We don't believe it's enough to push us into a recession. I don't think we're really talking about a recession until the global economy tips into a recession, and I think it would require a sustained period of oil prices around $150 a barrel before we would seriously be talking about a global recession.
Mike Miranda:
All right. Thanks for that perspective, Doug. Katherine, let's bring you into the conversation. Given the Iran war threatens subsea cables, how could this potentially affect the economy? And from a macro and economic perspective, how can investors prepare?
Katherine Krantz:
Sure. Thanks, Michael. Well, obviously, it's a major risk every day. This represents about 90% of daily internet and data traffic for the world, and all communications, military, financial data is dependent on these cables remaining open. With that said, there's always risk of an accident. There's risk of some kind of natural event, like an earthquake or a tsunami disrupting them. I think the question now is if there were to be some kind of deliberate attack on it as an aggressive move, that would be letting the toothpaste out of the tube, similar to what we're seeing with control of the Strait. Before this, nobody thought Iran would be able to do what they're doing. So if there were an attack on that infrastructure, then going forward, that would be a risk that you'd have to always be thinking about.
I think just generally, given the situation, you want to remain diversified. We've seen the dollar perform well when risks were heightened, showing that's still a reserve currency. But bigger picture, I think what you're going to see is that you're going to see governments and companies trying to beef up their defense of their critical infrastructure. So there's probably going to be some spending around that, making sure there are some alternatives in place. There are satellites, but they can't really soak up the entire bandwidth of what these cables do. So it remains a risk, but you also can't be positioned for every single geopolitical risk out there. So I think be smart on the edges, but you have to proceed as if it's status quo.
Mike Miranda:
All right. Thank you for that. Doug, let's bring you back to maybe talk about the implications for some of the markets. Is there anything at all you would like to say on the implications here for rates, inflation, and FX broadly?
Doug Porter:
Well, if we just back up a little bit to something that Katherine just said, I think the markets have really spoken quite loudly through this episode. It's interesting that if we work backwards and start with FX, the overall impact has been a mildly stronger US dollar, but compared to past episodes in recent decades, the flight to safety or the safe haven, the move has been very modest. It's traditional, but it's been quite modest compared to the past. The trade-weighted US dollar is only slightly higher than before this all began, and you can see how quickly the market almost seems to want to move away to that whenever there's a hint that tensions may be receding. I still do believe that if we get another flare-up, we'll get another slight rise in the US dollar, but really modest compared to things we've seen in the past.
On the rates side, I think this is maybe the most important fundamental move we have seen. In general, the market is assuming that we do have a little bit more upside headline risk for inflation. There's still some doubt whether it actually leads to anything more serious on the core front. But the generalized view is around the world, central banks have felt the need to either respond or talk about responding. We have seen some central banks actually go ahead and raise rates, like, for instance, just yesterday, the RBA. The Bank of Canada has actually openly talked about the possibility of having to hike a couple of times. The Fed rate cuts have been pretty much removed by the market, and that's being reflected in longer term bond yields.
But again, I would just stress that yields are not out of the range that we've seen in the last year. So even there, even with where I would say we've seen the most significant move in long-term bond yields, the move is not particularly large. I do think that if we get a renewed flare-up of hostilities again, you would see some upward pressure on long-term yields, but I don't believe they'd move out of the range of the past year.
Just the last comment, on the inflation front, it's pretty mechanical. Every 10% move in oil prices does tend to raise inflation in most advanced economies by a couple of tenths of a percent. It's been almost textbook in terms of the headline inflation readings we've received so far from Europe and from the US and Canada as well. The one thing I would warn is we had a record rise in gasoline prices in both Canada and the US in April. Well, they rose another 10% or so in the following month, and it looks like they're going to rise again here in May versus April's average.
Mike Miranda:
All right. Thanks, Doug. And you brought up some interesting points about recent market movements relative to history, so maybe let's touch a little bit on that history, and what I'm thinking here is the comparison to the 1970s. We often hear from clients this historical comparison. How does this environment compare with the oil shock that we had in the '70s? What's fundamentally different, and what, if anything, is similar here?
Doug Porter:
Yeah. I think just starting with what's similar, the amount of physical oil removed is somewhat similar. If anything, it's actually even a little bit larger.
The one major difference I would point to is just the dependency of the global economy, and the US economy in particular, on oil. It is just not in the same league as it was back then. For every unit of output that we would produce, we would need a whole lot more oil back in the 1970s than we do now. And in some ways, we can thank the two oil shocks of the '70s for making us less oil dependent, and basically, people, industries, households found efficiencies. They found ways to do things requiring less oil. It was a painful episode. And even since the '70s, there has been a slow reduction in the importance of oil.
Of course, the other big difference is the US economy is now self-sufficient in oil, and Canada is a significant oil exporter, and the US too is now a net exporter. So we are simply less dependent on the imported oil, much, much less vulnerable than we had been in the past. Again, that's not to say that this is a non-event for consumers. It's a very important event for consumers, but it's just not the mortal threat that it was back in the 1970s.
Mike Miranda:
Very helpful. Katherine, let's bring you back. Doug mentioned some points certainly on the movement of the dollar of late. I would love to unpack that a bit more with you. So against the dollar, the euro has struggled since the start of the Iran war, but it has started showing some signs of securing a firmer footing. So can you talk about expectations for currencies as the war continues to play out?
Katherine Krantz:
Sure, Michael. Yeah, I agree with Doug. Even though we've seen what we've called a normal response in terms of the dollar's reaction to heightened tensions, it has not been outsized. It has been muted.
Now, that said, when we started the year, before we knew about this conflict, we were calling for a global recovery. There's almost 90% of global GDP is derived in countries that have stimulus in the pipeline, so that's a huge global tailwind that was really pushing us toward a recovery. And it's very normal, in a backdrop like that, for the rest of the world to perform a little better and for the dollar to fall out of favor because people aren't looking for that safety. And so, really, what we've been seeing happening in the currency markets is pretty much in line with what we would expect. When investors get a little bit more worried about the backdrop, they may make a move toward something that's a little bit more safety-oriented, but when it's risk-on, we're seeing that subside because there's a lot of other options out there for investors to turn to.
Mike Miranda:
All right. That's very helpful. Doug, let's come back to you a bit on where we see central bank policy, and you touched on this a bit in your comments a couple of minutes ago. You've been steadfast and slightly contrarian that you don't see rate rises from the Bank of Canada this year. Is that still your view? And how do you see central banks in the US and Canada continuing to respond? Could anything throw a wrench into that view, as you see it right now?
Doug Porter:
A lot of things can throw a wrench into it. But to answer your question directly, we are still of the view that the Bank Canada is unlikely to move on rates this year.
Having said that, I will say the Bank of Canada sent an incredibly strong signal last week. Now, they tried to balance it out. They said if the USMCA negotiations go south on us, sour, they may have to cut. But at the same time, they also said that were oil prices to stay at a very elevated level and they see signs that it leads into broader inflation pressures, they may have to raise rates. But what really stood out for me is they didn't just say they may have to raise rates. They specifically said they may have to raise rates in a consecutive manner. In other words, a number of times. They didn't have to say that. All they had to say was, "Yes, we may have to raise rates." But they were very specific, and I found that to be quite a hawkish lean by the Bank of Canada. The market jumped all over it. It backed up Canadian bond yields quite notably last Wednesday following that Bank of Canada move. The market is now priced for more than two hikes by the Bank of Canada this year.
I will tell you, we're not alone, by the way, in saying that we think that's wrong and that the Bank of Canada will likely not raise rates. There actually are other economists who were saying the same thing. This is being pushed much more by market pricing. But of course, those are real dollars behind those calls. And I will say, we're in the business of forecasting what the Bank of Canada will do, not what we think they should do. And I am concerned that by sending such a hawkish message, we may be offside, that there is more of a risk than we believed that the Bank of Canada actually will raise rates.
I will give you a brief rundown as to why we think that would be a mistake to hike rates and why we think this is a very different episode than what we went through four to five years ago. And by the way, one of the main reasons why the Bank of Canada would raise interest rates is because they do not want to repeat the mistake that they made four or five years ago and let inflation run higher again. I do take that as a very important point. But the reasons why we think it's a mistake, first of all, four years ago, we were starting at zero. We are not starting at zero now. Rates are actually neutral. We were in the middle of a housing price boom four to five years ago. We're not there this time. The housing market is flat. If anything, prices are fading.
Third of all, four or five years ago, we were not faced with the overwhelming uncertainty of the trade negotiations with the US. We did not have this mortal threat of a breakdown in trade relations between Canada and the US. That's a really serious environment to be raising rates into. And finally, the other thing I would point out is four to five years ago, of course, we were just emerging from COVID. People wanted to spend. They didn't care what it cost. They were willing to go out and spend on goods and services. This time, there's no real rush to get out and spend. If anything, because of the backdrop, consumers are somewhat cautious. So we just simply do not believe that the argument is there for the Bank of Canada to be hiking.
The last thing I would point to, by the way, is four or five years ago, heading into the Ukrainian conflict when oil prices spiked, we had underlying inflation in Canada of 4%, we had underlying inflation in the US of 6%, and rising in both cases. Now, it's between 2% to 3%, and if anything, fading. So we just do not believe the backdrop is conducive to rate hikes as we look ahead.
Mike Miranda:
Thanks, Doug. What do you think about the US? I know that was certainly on your mind as well. Where do you see the Fed going from here?
Doug Porter:
Yeah. And generally, we have been Fed cutting twice later this year, but well after the conflict ended. I would freely admit that there is a very clear risk that the Fed might have to wait until 2027 when the smoke is completely clearer on this episode, when oil prices have really receded. Look, there's no rush for the Fed to be cutting. The economy is not particularly weak. We've got a full on AI boom going on, helping support the economy. So there's really no rush for the Fed to cut. So I could see them delaying those cuts into 2027.
Mike Miranda:
All right. Thanks for that, Doug. One last question before we bring Randy back in. We hear oftentimes, and you talked about it a little bit here with the boom in the US, but maybe this question specifically for Canada, is this environment actually an economic positive, or even a bonanza for Canada? And how do you frame that question? I know you made some comments before about the benefits to one segment of the economy at the cost of consumers. So how do you see the backdrop there?
Doug Porter:
Yeah. And I will freely tell you that there's all kinds of economic models out there that suggest that higher oil prices are actually a net positive for the Canadian economy, and that's simply because Canada is one of the largest oil exporters in the world, and obviously one of the largest producers in the world as a share of its economy. Oil is actually much more important to Canada than it is to the US. There's no question that it's a massive benefit to the producing provinces. Alberta and Saskatchewan, to a lesser extent, Newfoundland will benefit in a very significant way from this.
And of course, oil isn't the only story. We've seen natural gas, aluminum, fertilizer all affected by this. Canada is a net exporter of all those goods. You can probably find very few economies in the world that are more insulated than Canada is, and possibly even a small net beneficiary. I just happen to believe though that it's the rest of the economy and the consumers more broadly that are faced with such a big, sudden negative that, at least over the near term, actually outweighs those positives for the producing regions of the world. So no, it's not a bonanza for the Canadian economy broadly. It is arguably bonanza for Alberta and Saskatchewan. But it's a huge negative for Central Canada, for British Columbia, and arguably for much of Atlantic Canada as well. And we think the way that balances out, as I said, over the short term, is it actually ends up being a small negative for the Canadian economy, at least short term.
Mike Miranda:
All right. Thanks for that comprehensive view. Randy, let's bring you back in. How are energy companies responding to the crisis and high demand as the war goes on? And will we see more activity? And what shape will that take, from your perspective?
Randy Ollenberger:
Yeah. I mean, companies have been slow to really change their capital spending plans around this. The curve has been pretty steeply backward-dated. So we've seen oil prices at the front end up to $100 or higher, but the back-end has been pretty well anchored in that $75, $80 range. And so, that's not necessarily high enough to stimulate a substantial increase in spending activity.
That said, that cash windfall coming in the door right now does improve balance sheets and it does put companies in a position to contemplate a few more projects at the margin. So for example, the US Energy Information Administration had US production peaking in the first quarter of this year and then going into a slow decline. They've now changed that view, and see production actually continuing to grow through the end of 2027. So we are going to see a little bit more investment at the margin in the United States.
In Canada, really, what's happening is the shift in view from oil demand is peaking and we don't need any growth to oil demand is likely to continue to grow and we may need more strategic reserves built up around the world. It does create a bit of an opportunity for Canada with its immense reserves to perhaps consider some of those longer term projects that had been on the shelf, and of course, we need pipelines for that. And so, you're starting to see a little bit more effort put behind pipeline expansions, which in turn would grow Canadian oil production. Those capital programs are measured in years though, and so we'd be looking at capital programs in Canada perhaps starting to increase in '27 through 2030, but not much of a change this year.
Mike Miranda:
You talked a little bit about capital, and maybe a follow-up there, how much capital is available to the energy sector, and what are the long-term market drivers, from your perspective? Do you have a sense of what this will look like post the Iran war?
Randy Ollenberger:
So if we went back a decade or so, the oil and gas industry routinely outspent cash flow by about 20%, and so they'd access capital markets either for equity or debt to fund those programs. What's happened really since COVID is the industry's focused on reducing debt levels and living within cashflow. And so, now, we see capital programs that are, instead of 120% of cash flow, they are 80% of cashflow, or in some cases, even less.
And so, companies have access to capital in the context of they have very strong balance sheets, their cash flows are strong, and so they can fund really any growth projects they want for the very near term here, or maybe the next three to five years, simply from cash or perhaps a little bit of incremental debt at the margin. We really don't envision a big phase here where companies would go back to issuing equity to grow production. We think those days are done. We think oil and gas companies have much more capital discipline than they had 10 years ago, and we think that's not going to change.
Mike Miranda:
All right. Thank you for that. And thank you all three of you, Katherine, Doug, and Randy, thank you for your insights in helping us take a step back and consider how investment strategies and supply chains may change based on the economic and market outlook. We also considered the impact of heightened geopolitical risk on energy companies, asset prices, and decision-making. I appreciate your help navigating the uncertainties that we have ahead. And thank you to everyone who joined us for listening. And with that, thank you very much. Have a great rest of your day, everyone.
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The views expressed here are those of the participants, and may not necessarily represent those of BMO Capital Markets, its affiliates, or subsidiaries. For BMO disclosures, please visit bmocm.com/podcast/disclaimer.
