Insight

Israel-Hamas War – Market Outlook

Israel-Hamas War – Market Outlook

What is happening in Israel - Gaza is a travesty and our thoughts go to those that have been affected.

In sum, a widening war is possible but not the base case. There are powerful incentives for most parties to avoid an all-out regional war, which could be why markets are pricing for a contained conflict.

We believe that the war is not likely to have much of an impact on financial markets and that the price of oil is unlikely to see a sustained rise above USD 100/bbl.

Impact to Markets

Immediately after the attack, markets quickly pivoted towards being risk off.

Gold rallied, US Treasury yields fell in the first few days and the market shifted its expectations for the Fed to a modestly easier path.

US equities rallied because yields fell, led by growth stocks. The attack initially caused Israel’s stock market to decline 7% though price levels have stabilized since.1

The Israeli 10-year government bond yield initially rose by around 30 bps to 4.58% but has since fallen to 4.06% (well below where it was when the conflict started).2 That may seem odd but probably reflects the decline in US treasury yields (treasuries seem to have acted as a safe haven).

If the conflict widens and becomes prolonged, we would expect Israeli stocks and the shekel to weaken further but wouldn't be surprised to see local government bond yields rise.

More broadly in the Middle East region, of the conflict drives the oil price higher, we would expect stock markets to do better in countries such as Saudi Arabia, UAE, Qatar and Kuwait. On the other hand, Lebanese stocks (down only 3.4% so far) would likely be a casualty of an escalating conflict .3

In sum, we view what’s going on in Israel as a regional conflict, which typically does not have meaningful impacts on financial markets over time.

We don’t see the war altering growth trajectories of the major economies nor does it make the Fed more hawkish.

If anything, we believe that the Fed is less inclined to tighten going forward given the perception of heightened risks.

Oil Outlook

The one economic risk that could impact global markets is the potential for even higher oil prices. Oil initially spiked up 4%, but has since begun to ease.4

US policymakers have until recently turned a blind eye to Iranian oil exports slipping through US sanctions though that’s likely to change.

Washington is all but certain to tighten enforcement of Iranian oil sanctions, which could further restrain already tight global supplies.

While the removal of Iranian oil from the market could push oil prices higher, I believe the Saudis alone could increase production and fill the void without breaching existing quotas or consulting OPEC+ .

While there is an incentive for the Saudis and OPEC to want to see oil prices above USD 80/bbl, oil producing countries don’t want to see demand destruction or an acceleration to alternative energies, which would certainly happen if oil breached USD 100/bbl for an extended period.

EM resource-rich regions such as LatAm, South Africa and Gulf Cooperation Council (GCC) are likely to outperform EM Asia in the near-term because of differences in the terms of trade.

Geopolitical Outlook

The situation remains fluid though it’s becoming clear that an Israeli ground invasion could be imminent.

The ensuing invasion amplifies the risk that the conflict could spread from Gaza to the wider region and drag in further actors such as Hezbollah and Iran.

While the metastasis of the conflict is certainly a possible scenario, we believe that it’s unlikely.

Historical Examples

The market seems to be running by the playbook of the recent conflicts involving Israel, Gaza or Lebanon of the last 20 years, rather than earlier decades.

History tends to suggest that investors shouldn’t overreact to military conflict.

In five of the six examples shown, the markets experienced a sharp decline at the onset of the conflict only to recover over the year.

The notable exception is the war in Afghanistan in which the US was already mired in a recession.

S&P 500 Index during past military conflicts
S&P 500 Index during past military conflicts

Source: Bloomberg, 2/22/22.  For illustrative purposes only. The S&P 500 Index is a market-capitalization weighted index of the 500 largest US domestic stocks.  Indices cannot be purchased directly by investors. Price returns are in US dollars.

Military conflicts tend to not weight on markets as much as investors believe. History suggests that military conflicts have not derailed the long-term advance of financial markets. 

S&P 500 Index
S&P 500 Index

Source: Economic Policy Uncertainty, 5/22. The Caldara and Iacoviello GPR index reflects automated text-search results of the electronic archives of 10 newspapers: Chicago Tribune, the Daily Telegraph, Financial Times, The Globe and Mail, The Guardian, the Los Angeles Times, The New York Times, USA Today, The Wall Street Journal, and The Washington Post. Caldara and Iacoviello calculate the index by counting the number of articles related to adverse geopolitical events in each newspaper for each month (as a share of the total number of news articles).

With contributions from Brian Levitt, Arnab Das and Paul Jackson. 

Footnotes

  • 1

    Source: Bloomberg, as of Oct 9, 2023 

  • 2

    Source: Bloomberg, as of Oct 12, 2023 

  • 3

    Source: Bloomberg, as of Oct 12, 2023 

  • 4

    Source: Bloomberg, as of Oct 12, 2023 

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