Over the past several months, Middle Eastern conflicts and supply shocks have intensified extreme K-shaped divergence in global markets. We assess that geopolitical risks in the Middle East face underlying pressures toward protracted instability, potentially persisting in a state where parties fail to reach a stable agreement, hostilities intermittently flare and subside, and transit through the Strait of Hormuz experiences periodic disruptions. Key reasons include the long-term nature of Iran’s strategic objectives, which inherently complicates the situation; the Houthi involvement is primarily aimed at securing 'political recognition' from various stakeholders rather than merely aligning with Iran; and it would be unwise to overestimate the restraining influence of the U.S. midterm elections on Trump’s decisions regarding military action.
However, historically, grand geopolitical narratives often lead to expectation 'desensitization' following periods of extreme positioning. Changes in geopolitical dynamics and shifts in market expectations do not always align temporally—a clear example being the tariff shocks since last year, after which market styles tended to rebalance once expectations were fully priced in.
Additionally, significant attention should be paid in the second half of the year to potential developments in the Russia-Ukraine crisis. Should substantive negotiations commence among relevant parties, the lifting of sanctions on Russia would likely become a critical bargaining chip. Such an outcome would offset, in terms of market expectations, the geopolitical risks and supply-side pressures emanating from the Middle East, thereby breaking the current impasse between geopolitical risk and market sentiment.
Over the past several months, Middle Eastern conflicts and supply shocks have intensified extreme K-shaped divergence in global markets. We will address several key questions arising from this geopolitical narrative.
Looking back from late 2025 to early 2026, the HALO trade was catalyzed by the fading impact of tariff-related expectations, synchronized recovery in global manufacturing PMIs, and declining U.S. dollar strength and interest rates. However, Middle Eastern hostilities and energy supply disruptions linked to the Strait of Hormuz shattered this narrative, exacerbating the extreme K-shaped market divergence observed over recent months. At the current juncture, could the risk of war in the Middle East become protracted? What factors might break this deadlock?
Question (1): Will the Middle Eastern conflict become protracted?
We believe that the long-term nature of Iran’s strategic objectives determines the complexity of the situation, making it likely that the Middle East will remain in a state where stable agreements cannot be reached among parties, hostilities continue intermittently, and transit through the Strait of Hormuz faces recurring disruptions.
1) Iran may currently place greater emphasis on its long-term strategic goals, viewing the present circumstances as a historic opportunity to reshape the Middle Eastern geopolitical landscape and break through the U.S.-led strategic containment and encirclement. Given the severe lack of political trust between the U.S. and Iran, ensuring transit through the Strait of Hormuz represents Iran’s most potent negotiating leverage.
2) We believe the professional capacity of the U.S. diplomatic team significantly affects the difficulty of resolving the impasse. Objectively speaking, since the beginning of Trump’s second term, numerous personnel from traditional U.S. diplomatic and security institutions have undergone large-scale 'purges,' and repeated instances of inadequate diplomatic expertise have already led to complications—evident in prior efforts to coordinate Gaza peace talks and Russia-Ukraine negotiations. The U.S.-Iran 'Islamabad Memorandum of Understanding' is logically flawed: it treats deeply entrenched, complex historical disputes—such as those concerning proxy forces, sanctions relief, and nuclear issues—as assumed preconditions, while treating the reopening of the Strait of Hormuz as an outcome. This approach makes the memorandum highly vulnerable to collapse if its foundational assumptions unravel. Furthermore, the memorandum contains numerous vague and broadly worded principles, creating interpretive challenges—for instance, both sides currently hold starkly divergent views on whether Clause 5 implies U.S. recognition of Iranian control over the Strait. For further analysis on the complexities of U.S.-Iran negotiations, refer to the report titled "Geopolitical Biweekly Digest (24)—Is There a Risk of Protracted Stalemate in the U.S.-Iran Conflict?" (2026-07-13) and "Geopolitical Biweekly Commentary (23)—Outlook on U.S.-Iran Negotiations: Motivations, Obstacles, and Implications》（2026-06-22）。
3) Taking the above factors into account, we believe there is a risk that Middle Eastern hostilities and supply-side shocks could become protracted, potentially resulting in a prolonged state where no stable agreement can be reached among the involved parties, intermittent fighting continues, and navigation through the Strait of Hormuz and the Bab el-Mandeb Strait faces periodic disruptions. Particularly as strategic energy reserves are depleted, the ability of certain global economies to absorb energy price shocks has weakened compared to recent months, further complicating the situation.
Question (2): What impact does the involvement of the Houthis have?
We believe the Houthi movement’s recent involvement in the conflict is not merely an act of coordination with Iran but rather an attempt to secure 'political recognition' from various stakeholders. Their actions are primarily driven by long-term strategic objectives and may lead to sustained risk spillovers affecting the Bab el-Mandeb Strait.
1) Recently, Yemen’s Houthi forces announced a maritime blockade against Saudi Arabia, raising market concerns about potential disruptions to shipping through the Bab el-Mandeb Strait. From the perspective of each party’s motivations: the Houthis aim to use control over the Bab el-Mandeb Strait as leverage to bolster their regime’s legitimacy; Saudi Arabia seeks to safeguard its southern border and secure oil exports along its western coast; Iran welcomes the Houthis opening a new front to divert pressure; and the United States has no interest in engaging in multi-front conflicts.
2) We believe the Houthis’ decision to enter the fray at this juncture is not solely aimed at coordinating with Iran under a 'united front against the U.S.' Rather, they are leveraging the current regional turmoil to amplify threats against Saudi Arabia and seek 'political recognition' from key actors. Short-term economic gains are not central to their calculus. For a more detailed assessment, please refer to the report entitled "Overseas Policy Commentary (87)—The Geopolitical Game Behind the Houthi 'Blockade'》（2026-07-23）。
3) Under our baseline scenario, we expect the Houthis and Saudi Arabia to maintain a low-intensity pattern of 'pressure-and-response' engagement. However, given the long-term nature of the Houthis’ current strategic objectives, risks may not dissipate quickly, potentially triggering risk linkages between the Strait of Hormuz and the Bab el-Mandeb Strait and further exacerbating the complexity of the Middle East situation.
Question (3): Could midterm election pressures lead to a breakthrough?
We believe that as long as the likelihood of the Republican Party losing control of the Senate continues to diminish, Trump will face limited political pressure on issues such as investigations, impeachment, electoral disputes, and Supreme Court appointments. Market expectations may therefore overstate the constraining effect of the midterm elections on Trump’s conduct regarding military actions.
1) Although the U.S. midterm elections will affect Trump’s personal political interests and legacy—particularly whether he and his key allies face investigations or even impeachment—the likelihood of both the Senate and the House flipping control simultaneously remains low based on current conditions.
2) Market expectations are relatively well-prepared for a Democratic takeover of the House of Representatives. Even if Republicans continue to aggressively push for gerrymandering, they are unlikely to reverse their disadvantage.
3) Regarding the Senate, because not all seats are up for election due to procedural rules, control of the chamber often diverges from current polling trends. The composition of this year’s Senate races is highly unfavorable for Democrats. Among the eight competitive Senate seats—in Georgia, New Hampshire, Michigan, Alaska, Ohio, Maine, Texas, and Iowa—Democrats may need to win six of them. If we further account for the effective 'defection' of incumbent Democratic Senator Fetterman of Pennsylvania, Democrats might need to secure seven of these eight seats—a highly challenging prospect.
4) Should a split Congress emerge, it would imply that politically damaging actions against Trump are unlikely to materialize. Notably, appointments to the U.S. Supreme Court remain under Republican control; even if Justices Thomas and Alito step down, Trump could nominate new conservative justices, thereby continuing to shape the U.S. political landscape over the long term. Overall, it is overly simplistic to assume that electoral pressure alone would necessarily compel Trump to make fundamental concessions on Middle East issues.
Question (IV): Will geopolitical narratives continue indefinitely?
Historically, disruptions stemming from grand geopolitical narratives tend to lose market sensitivity after reaching extreme levels of crowded positioning—an effect exemplified by last year’s tariff shocks.
1) Based on the above analysis, we believe that geopolitical risks in the Middle East carry potential for long-term persistence, but this does not necessarily imply prolonged market impact. Objectively speaking, shifts in geopolitical dynamics and shifts in market expectations are not always synchronized in timing. For major geopolitical risk events, market effects typically follow a transmission sequence of 'short-term event shock → medium-term policy adjustment → long-term structural realignment.' In particular, once impacts enter the 'long-term structural realignment' phase, they manifest more as structural rather than aggregate influences. For a detailed methodological discussion on geopolitical analysis, please refer to the report entitled "Global Geopolitical Outlook for the Second Half of 2026: Resilience Competition Under Strategic Restraint》（2026-05-22）。
2) Looking back at Trump’s second term, the extreme U.S. tariff shocks serve as a prime example. Although tariff impacts persist and will continue reshaping global supply chains, this does not mean tariffs will remain a pivotal variable in market trading. Since the fourth quarter of last year, as market expectations have been digested and global supply chains have adapted, investor attention to tariff changes has steadily diminished.
3) Therefore, even if Middle East geopolitical risks become protracted, after an initial period of short-term expectation volatility—and especially following extreme crowding in trading and positioning—market sensitivity to developments in the region may gradually 'desensitize.' In this process, HALO assets previously suppressed by geopolitical risk could regain some investor attention.
4) In addition to geopolitical risks in the Middle East, disruptions in China-EU economic and trade relations represent another potential geopolitical factor weighing on HALO assets. However, based on a detailed analysis of the EU’s political system and policy instruments, we believe that potential China-EU trade frictions are unlikely to fundamentally disrupt the logic underlying global industrial layout. For a more detailed assessment of China-EU economic and trade relations, please refer to the report titled "Overseas Policy Special Report (59)—Mechanisms and Impacts of Potential EU-China Trade Frictions"》（2026-06-15）。
Question (5): What geopolitical factors could offset the geopolitical risks emanating from the Middle East?
We believe that in the second half of the year, close attention should be paid to potential developments in the Russia-Ukraine crisis. If the involved parties enter substantive negotiations, the lifting of sanctions on Russia would likely become a key bargaining chip, thereby offsetting—on an expectation basis—the geopolitical risks and supply-side pressures stemming from the Middle East.
1) Among the many geopolitical flashpoints expected in the second half of this year, we recommend maintaining heightened vigilance regarding potential shifts in the Russia-Ukraine crisis. Compared with previous years, we believe the conflict parties now have both the motivation and foundation to enter substantive negotiations—for example, Ukraine’s growing drone production and strike capabilities, Russia’s battlefield response, and Trump’s stated inclinations.
2) We believe that Russia-Ukraine peace talks would likely proceed in stages, sequentially addressing issues such as ceasefire arrangements, territorial control, lifting of sanctions on Russia, post-war security guarantees for Ukraine, and U.S. strategic posture toward Europe. Given the complexity of the conflict, negotiations are unlikely to yield immediate results. However, from a market expectations perspective, the mere initiation of substantive talks could prompt global markets to begin pricing in a gradual removal of sanctions on Russia. This would imply potential shifts in supply expectations for energy, grains, and metals, as well as revised expectations for the European economy—possibly leading to a marginal weakening of the U.S. dollar. These expectation adjustments could help counterbalance the prolonged pressure from Middle East geopolitical risks and potentially break the current market impasse. For an analysis of the broad asset implications under the hypothetical scenario of lifted sanctions on Russia, please refer to the report titled "Geopolitical Conflict Watch—How to Interpret the Russia-Ukraine Peace Process and Its Potential Impacts?"》（2025-02-23）。
Risk factors:
Geopolitical situation in the Middle East deteriorates beyond expectations; geopolitical situation related to Russia-Ukraine deteriorates beyond expectations; China-EU economic and trade relations deteriorate beyond expectations; global geopolitical risks rise beyond expectations.
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