Daily Management Review

How Middle East Tensions Could Severely Impact Various Markets


How Middle East Tensions Could Severely Impact Various Markets
An expansion of the Israel-Gaza dispute into a larger conflict might provide another shock to global GDP and halt disinflationary forces in their tracks.
So far, market reaction has been muted, but this could change.
"Whether this conflict remains limited to a confrontation between Hamas and Israel or escalates into a broader regional conflict involving Iran's proxy armed groups, notably Hezbollah, will have significant implications," said Hamza Meddeb, director of the political economy programme at the Malcolm H. Kerr Carnegie Middle East Center in Beirut.
"Such an escalation could lead to increased oil prices, concerns about oil supply, and the potential for a global economic downturn."
Here are some scenarios to consider.
Iran, Then Oil
The possibility of Iran becoming more involved, as well as a US response that includes more restrictions on Iranian oil, is in the limelight.
"A crackdown on Iranian oil exports could immediately remove somewhere from 1-2 mbd (million barrels per day) off (the) market almost instantly," said hedge fund Cayler Capital's founder and CIO Brent Belote.
In the improbable event that the US sends soldiers into the Middle East, Belote predicted a $20 increase in oil prices, "if not more."
On Wednesday, oil rose more than 2% to more than $92, having risen 7.5% in the previous week.
Oil rose more than 300% from October 1973 to March 1974, when the Yom Kippur war spurred Arab nations to impose an oil embargo on Israel's allies.
"Israel has better relations with other Arab countries compared to then," JP Morgan private bank strategist Madison Faller said in a note, "and global oil supply is not as concentrated."
A regional conflict, according to Nadia Martin Wiggen, director at commodity investor Svelland Capital, would impede oil ship routes in the Mediterranean, Black Sea, and surrounding Turkey.
Inflation Spike?
Inflationary pressures have subsided, and global rate hikes are coming to an end.
A rise in oil prices, which temporarily reached $139 after Russia's invasion of Ukraine last year, might halt the declining trend in inflation. Another troubling clue is that petrol prices increased by 45% last week.
"If Iran gets involved that means higher commodity prices, higher external shocks, and this is a trigger for a less disinflationary outlook," said Alessia Berardi, head of emerging markets macro and strategy research at Amundi, stressing this was not her base case.
Long-term market indicators of US and eurozone inflation expectations point to inflation remaining over 2% objectives.
Bond investors may face additional hardship. The S&P U.S. aggregate bond index, which measures the performance of Treasuries and corporate debt, is 14% lower than its peak in January 2021.
A Strong Dollar?
Demand for safe-haven assets has strengthened the dollar, pushing it beyond 150 yen, as well as the Swiss franc, which had its best day against the euro since January.
According to Amundi's Berardi, the dollar may not be a one-way bet if rising oil prices and inflation cause a U.S. recession.
According to Trevor Greetham, Royal London’s head of multi-asset, any “global risk-off move” might strengthen the yen as “Japanese investors pull their money home.”
Submerging Markets
The currency, bonds, and equities of Israel have been damaged, as have those of Egypt, Jordan, and Iraq, as well as, to a lesser extent, Saudi Arabia, Qatar, and Bahrain.
Following a terrible number of years, the Israel-Gaza conflict "is just one more thing dampening emerging market sentiment," according to Omotunde Lawal, Head of EM Corporate Debt at Barings.
She is cautiously optimistic that most other emerging economies are currently ignoring tensions. Morgan Stanley also does not anticipate contagion.
However, Jeff Grills of Aegon Asset Management cautioned that a regional escalation could "easily" cause oil to rise 20%, harming dozens of already destitute oil-importing countries.
Tech Jitters
What is beneficial for energy equities may be harmful to big tech.
In 2022, MSCI's global tech index traded inversely to oil and gas equities as the war in Ukraine pushed up oil prices, stoking inflation fears that were captured by higher bond yields.
That trend could reappear, according to Greetham of Royal London, if US interest rates rise again to counteract the inflationary effects of the present battle.
Infrastructure disruption is also a possibility.
"Egypt is one location where multiple intercontinental cables cross land in a digital Suez Canal," Deutsche Bank said. "At least 17% of global internet traffic crosses this route."
Meanwhile, airline companies may suffer while defence stocks outperform. MSCI's airline equity index is down nearly 5% since the Oct. 7 Hamas bombings in Israel. Aerospace and defence stocks are up about 6%.