International Markets Brace for Impact as Middle East Tensions Rise

Tensions in the Middle East have international markets bracing for impact as investors eye risks that could increase oil prices if other countries become involved with Israel’s war against Hamas. 

Sunday, Israel said it would continue to allow residents of Hamas-controlled Gaza to evacuate south as the Israel Defense Forces prepare to respond with a ground assault in response to the unprecedented terror attack from Hamas last weekend that killed more than 1,300 Israelis.

Oil prices spiked almost 6% Friday as investors priced in the risks associated with a more wide-reaching Middle East conflict, while the S&P 500 index fell 0.5% in the day’s trading. Prices for European natural gas also surged to their highest levels since March, while an Israeli gas field that supplies Jordan and Egypt was shuttered temporarily, which raised concerns about supply.

“It looks like we’re headed for a massive ground invasion of Gaza and a large-scale loss of life,” said a senior fellow in the Energy Security and Climate Change Program at the Center for Strategic and International Studies (CSIS) Ben Cahill. “Anytime you have a conflict of this scale, you will have a market reaction.”

Investors surged toward safe-have assets, which pushed prices up by over 3% while the U.S. dollar strengthened to a one-week high, and prices for Treasuries rose. 

Market reaction was somewhat muted during the first week of the war, although the Israeli shekel is trading at a seven-year low of 3.87 against the dollar. The central bank of Israel sold up to $30 billion in foreign currency reserves last week to help its currency to stabilize.

If the conflict spreads, it would likely cause inflation to increase, which would spur central banks to try to control the price spike by accelerating rate hikes, according to the chief global economist at The Economic Outlook Group, Bernard Baumohl.

Baumohl noted that while other countries are likely to see rates rise in this scenario, the United States could be an exception if investors pour capital into Treasuries, which would cause the dollar to strengthen and rates to fall.

“I have no clue whether markets will remain relatively well-behaved,” said group chief economics adviser at UniCredit, Erik Nielsen. “It almost certainly depends on whether this latest conflict remains localized or whether it escalates into a broader Middle Eastern war.”

Traders are preparing for another week of wild price swings

Traders are preparing for another wild week of price swings as the Middle East’s continuing conflict prompts investors to reconsider their views on global interest rates and fuels demand for haven assets. 

Japan’s yen, the U.S. dollar, and the Swiss franc — all traditional refuges in turbulent times — will be in focus on Monday as markets reopen at 5 a.m. in Sydney. Risk-sensitive currencies, including the Australian dollar, saw early selling at the open last week and could be under pressure again. Friday, gold surged by the most since March.

The market will also scrutinize Treasuries and oil prices after a tumultuous week in which bonds swung between the largest losses and gains in years. Israel’s TA-35, the main share index, resumed its decline on Sunday.

The Israeli army has said it’s preparing for “significant ground operations” in Gaza. In the meantime, the U.S. has recently held back-channel talks with Iran to warn the country against escalating the conflict. Antony Blinken, U.S. Secretary of State, will make a second stop Monday in Israel after crisscrossing the Middle East with stops in Qatar, Jordan, Bahrain, the United Arab Emirates, and Saudi Arabia.

According to Bloomberg Economics, a broader war in the Middle East risks tipping the international economy into recession. That has added concern to investors’ growing worries about whether the Federal Reserve has finished increasing interest rates and how a leaderless U.S. Congress can avert a government shutdown.

A worsening macro environment has “set the stage” for global volatility to pick up, said Ed Al-Hussainy, a global rates strategist. International investors are closely watching whether the Hamas-Israel war spills over into the rest of the region. Still, currency traders will continue to remain more focused on the Fed, said Al-Hussainy.

There is plenty of uncertainty in the United States to spur additional market fluctuations. Last week, a hot inflation report boosted bets on a further rate increase by the Fed. However, the Middle East conflict remains the most significant wildcard for investors to digest.