“Both sides are for now behaving rationally, clearly aware of the potential consequences of their actions.”

Is it too late to save the 2015 Joint Comprehensive Plan of Action (JCPOA)?

Donald Trump pulled the US out of the treaty unilaterally in May 2018. Afterwards, the US set out 12 stringent preconditions for returning to the negotiating table in a move that to some has resembled a diktat. By achieving an extra-territorial application for its decisions and sanctions, the US has succeeded in neutering an agreement that had the backing of the international community. The deal could still be revived, but only if the Trump administration gives itself space to bring it out of limbo. The US is actually trying to reverse the gains made by Iran and its allies since the US pulled out of Iraq (2011) and since Syria’s civil war. The Trump administration also wants to deprive Iran of ballistic missiles, which it sees as a way for the regime in Tehran to advance its geostrategic interests in the region (but Iran itself sees as a deterrent against aggression).

In any event, Iran has forfeited the benefits of the JCPOA deal and lost all incentive to abide by its terms. Iran's leaders recently startedreneging on their commitments (albeit gradually with the ability to back-pedal), given that the other signatories were not standing by theirs. Iran may even be tempted to see nuclearisation as a kind of insurance policy or a significant bargaining chip in any future talks with the US.

How far could the current crisis escalate?

By threatening a partial, gradual and reversible withdrawal if the five other signatories fail to uphold their end of the bargain (i.e. the lifting of sanctions), the Iranian authorities will try to push them into a corner. If that fails, Iran could start on a course to obtain nuclear power. But if Iran did that, it could find itself at odds with the IAEA and run the risk of the Security Council ruling against it, which would then leave the Trump administration more leeway to proceed with air strikes. Policy hawks in the US would conceivably stop at nothing to cripple Iran’s ability to restart its nuclear programme. Such a prospect is a long way off, but it could involve intense air raids and missile strikes against Iran’s nuclear installations. The US might even go as far as using a tactical nuclear weapon to target underground facilities, should its ‘mother of all bombs’ (used in Afghanistan in 2017) prove insufficiently powerful.

But overall, both sides are for now behaving rationally, clearly aware of the potential consequences of their actions. The Iranians have upped the ante slightly, but recent incidents in the Gulf have been small scale. An important risk mitigant is the collegial system of decision-making in Iran, made up of institutions and persons with considerable experience in international relations.

There are also checks and balances wired into America’s political (and military) complex that can be expected to kick in when the occupant of the White House tries to push his presidential powers to the limit. In any case, at this stage, i.e. late June 2019, Trump has been relatively cautious. Granted, the president’s coterie includes figures who are in favour of using the military option against Iran, but the closer we get to the US presidential elections, the less likely it is that a large-scale military campaign will be on Trump’s agenda.

However, there is a risk the opposing parties could stumble into direct military confrontation. That could arise from a skirmish (in the Gulf or in Iraq) between US and Iranian (or pro-Iranian) forces that would then degenerate into full-scale hostilities. What marginally mitigates this risk is that both sides are aware of the danger and have professional command and control structures.

Escalation could also result from a miscalculation, as has often happened in the Middle East’s chequered history. The US could overestimate the power for sanctions to subjugate Iran into doing America’s bidding, tempting it to wade in militarily, possibly through air strikes (to start with at least).

For their part, the Iranians could underestimate Trump’s ability or willingness to wage war as a last resort, despite the risks involved. Saddam Hussein made the same error of judgement in 1990 when he invaded Kuwait.

How long can the Iranian regime survive the current sanctions? Could one envisage a Venezuela-type situation?

The state of decay of the Iranian economy and regime is still light years away from Venezuela, and the prospect of a regime change by way of a popular uprising, backed by token support from the US, seems implausible at this stage. To bring about such a change, the US would probably have to cross a red line by taking out all of Iran’s top political leaders, or by sending hundreds of thousands of soldiers into Iran's vastness. This could eventually involve the appearance of a ‘failed state’, as in Iraq in the years following the 2003 US invasion (although Iranian institutions are far more robust).

If a coup d’état did take place in Iran, it would more likely be the hardliners trying to force out a president and government that they see as too soft towards the Americans. However, the president – who in the past has shown signs of moderation – has given pledges to the hardliners in recent months, which has mitigated this risk for the time being.

China and Europe seem to be content to stay on the sidelines. Are they that afraid of antagonising the US?

European national leaders have reacted haphazardly and on the whole unenthusiastically, clearly so as not to strain an already troubled transatlantic relationship. More surprisingly, while they have given vocal support to Iran, both Moscow and Beijing have avoided circumventing US sanctions too overtly. Most likely, Beijing has enough on its plate with the trade spat with Washington.

Where should investors turn at a time like this?

So far, neither the price of crude nor financial markets have been shaken by the rising stress in the Gulf, even though 30% of the world’s seaborne crude-oil purchases pass through the Strait of Hormuz. There are two possible explanations.

One is that market participants are complacent and focused instead on positive fundamentals such as economic growth and, perhaps even more, the continuation of looser monetary policies by central banks. Consequently, risks that are not strictly economic, such as geopolitical risks (always hard to assess), are ignored.

Conversely, we may be witnessing a fair appreciation of geopolitical events. Ultimately, neither the US nor Iran wants war. Investors correctly surmise that the war of words and the isolated incidents are merely gesticulating and do not risk spoiling the global economic or financial backdrop.

But while we can currently assume that Iranian and US leaders are thinking rationally, and large-scale military conflict is not the most likely outcome, a dangerous chain reaction cannot be ruled out. Investors need to keep a close watch on this complex game of chess in which the pieces are constantly moving. A diversified portfolio that has a fair but not excessive share of risk assets equipped with mechanisms to cushion against sudden negative events is the most suitable response to the situation in the Gulf and elsewhere.

Read the full interview