Financial Markets

I have been puzzled why financial markets have been so slow to react to the US/Israeli attack on Iran, and the subsequent closure of the Straits of Hormuz.

Sarah Conor explains why.

Financial markets treat the economy as an engine driven by monetary policy. Reality dictates otherwise. At its base, the economy is an energy processing mechanism. Central banks cannot print oil or other commodities.

As we enter week three of the Strait of Hormuz closure in March 2026, macroeconomic models fail because they misdiagnose the problem. Physically removing 10-20% of oil and natural gas consumed starves the global engine. Perhaps for the best, although not without significant pain most collapse-aware predicted would one day arrive.

What’s unique about this shock is that it originates on the supply side.

Typically, a demand shock originates in the financial layer. The 2008 Great Financial Crisis and the 2020 COVID-19 lockdowns serve as examples. In these scenarios, the infrastructure of the world remains intact, but consumers stop buying. Credit freezes or governments mandate business closures causing prices to fall. Central banks solve demand shocks by lowering interest rates and injecting fiat currency to stimulate consumption.

A supply shock originates in the physical layer. The current Hormuz closure is a supply shock. Consumers (by consumers, I am referring to any buyer – individuals, businesses, governments) have the means and will to buy, but physical goods vanish. As a result, production halts because the baseline input is absent.

Shortages push prices up. Unlike demand shocks, central banks are stuck in a stagflation trap. Inflation requires contractionary policy to starve demand, but weaker production requires lower rates to offset demand destruction. Monetary policy cannot fix a physical deficit.

The problem with modern economics is that it models financial, but not necessarily physical, reality. It assumes consumers reallocate spending to cover higher energy costs, creating demand destruction elsewhere. This is a miscalculation.

When 10% to 20% of global oil, natural gas, and fertilizer leaves the market, those raw materials cease to exist for the end user. Capital cannot substitute for physical joules of energy. A freight network cannot run on fiat currency and nitrogen-based synthesis requires physical gas. Most market traders were not around during the 1973 oil crisis, so they dont understand the current situation.