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Update: Oil surges as US airstrike kills Iranian commander

Oil prices climbed Jan. 3 after a leading Iranian military commander was killed in a U.S. airstrike in Baghdad on Jan. 2, raising fears of an outright armed conflict between the U.S. and Iran.

Qassem Soleimani, a general who headed the Islamic Revolutionary Guard Corps' elite Quds Force, was killed in an airstrike at the Baghdad International Airport, Iranian and U.S. officials confirmed. Abu Mahdi al-Muhandis, the deputy leader of the Iran-backed Iraqi militia group called the Popular Mobilization Forces, was also killed in the strike.

The U.S. Department of Defense said the strike was "aimed at deterring future Iranian attack plans." Secretary of State Mike Pompeo tweeted that the U.S. would continue to protect its interests and allies but that it also remains committed to de-escalating tensions.

Iranian President Hassan Rouhani vowed that his country would retaliate for what he called a "heinous crime," echoing a warning of "severe revenge" from Iran's Supreme Leader Ayatollah Ali Khamenei, the Islamic Republic News Agency reported. Iran also named Brigadier General Esmail Ghaani as Soleimani's successor.

Brent crude had surged 4% to $68.88 per barrel on the ICE Futures Exchange by 6:30 a.m. ET, having previously hit $69.16 a barrel, the highest since September 2019. West Texas Intermediate also climbed 4%, to $63.65 per barrel, having earlier jumped to $64.09, its highest level since April 2019. Oil prices had pared their gains by noon ET.

Impact on global growth, markets

The focus now shifts to the potential severity of Iranian retaliation, which could include attacks on oil tankers in the Gulf, disruption of oil flows through the strategically important Strait of Hormuz and attacks on oil infrastructure of U.S. allies in the region, according to strategists at ING Economics.

If Iran tries to close off the Strait of Hormuz, Brent crude could jump to $150 per barrel, pushing up inflation by 3.5 to 4.0 percentage points in member countries of the Organisation for Economic Co-operation and Development, Capital Economics wrote. The projected oil price rally, however, may be short-lived as supply networks adjust and demand weakens.

A collapse of the Iranian economy as a result of any full-blown military conflict with the U.S. could reduce global GDP by as much as 0.3 percentage point, matching the damage seen from the trade tensions between the U.S. and China, Capital Economics added.

In the event of a severe escalation of tensions, overweight positioning in risk assets could lead to a 7% to 10% correction in global equity markets, according to the ING strategists. "[W]ere an equity correction to materialize, the Japanese yen should once again outperform — especially against those risk-sensitive currencies directly exposed to oil exports via the Strait of Hormuz," they said.