Last year, the Bush administration pounced on Iraq as an important pawn in its overall strategy for the Middle East. Evidently, those plans have now gone awry and the United States is finding it increasingly difficult to contain the chaos. As a result, the continuing instability is becoming of greater concern for investors.

It is difficult to see how the Iraqi situation can be stabilised in the near term, which means that it has the potential to roil markets as further flare-ups occur. Furthermore, it would be wise to keep an eye on the possibility of spill-over into surrounding countries.

It has now become part of the sporting scene to heap blame and contempt on the Bush administration. But, in fairness, we should note that a dispassionate reading of the history of any country will throw up countless examples of decision-making based on arrogance, miscalculation and misinformation. And if that isn?t bad enough, the errant decision-makers often fail to learn from their mistakes.

Oil prices have reached record highs, as traders discount the possibility that OPEC can expand output sufficiently, in the short run, to meet demand. Underlying demand is healthy because the global economy is still advancing at a rapid clip. But speculation is also adding to the problem as assorted investors and hedge funds place bets on oil. As we all know, higher energy prices have a dual impact on the economy. First, they reduce demand because they act as a tax on consumption. Some of the proceeds of this ?tax? are transferred to OPEC. But their propensity to consume may not be as high as the taxed entities, which means that global aggregate demand may be lowered as a consequence. Second, there is a tendency for a rise in inflationary pressures, as higher costs are passed on.

Nominal oil prices are high, on historical comparisons, but as every analyst with a calculator has figured out, they aren?t particularly high in real terms. So there is no need to press the panic button, yet. Indeed, the world economy can cope with current prices without too much damage to activity. Going forward, a slower pace of growth in China and elsewhere is likely to lead to a downward correction of high prices to more moderate levels.

What?s currently worrying some investors is the possibility of a supply shock if there are major disruptions in the Middle East. However, translating heightened political risk into the probability of untoward one-time events is very tough to do. But that won?t stop the waxing and waning of collective concern about what may happen ? depending on how much firework is reported in the news.

The stock market is taking a beating, and sectors with some of the best earnings performances have suffered the worst hammering. At some point, there has got to be a bit of a relief bounce, because the economic picture isn?t all that bleak. Mind you, there is a combination of factors out there that may continue to promote choppiness.

As for the interest rate outlook, the pain caused by higher oil prices will give the Fed an additional reason to go easy on hiking rates. With job creation on the rise, the household sector is at long last getting an income boost from employment growth rather than from tax giveaways. But there are new dangers lurking in the background, in the form of higher oil prices, greater geopolitical uncertainty and rising interest rates.