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Israel-Gaza war: how does it affect markets and the economy?

Israel-Gaza war: how does it affect markets and the economy?

The escalation of the conflict in the Gaza Strip is generating a typical pattern of risk-averse market movements across asset classes.
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16 OCT, 2023

By Constanza Ramos


The Hamas offensive in southern Israel last Saturday is having a serious impact on the Gaza Strip. A Palestinian area where more than two million people live in extremely difficult conditions. In addition to the constant air strikes by the Israeli army over the last three days, the Netanyahu government has chosen to impose a complete blockade on the area.

International fund managers have been quick to analyze the possible consequences for financial markets and the economy of the Israeli-Palestinian conflict.

How does the Israeli-Gaza war affect financial markets?

Maximilien Macmillan, Investment Director of abrdn

The escalating conflict in the Gaza Strip is generating a typical pattern of risk-averse market movements across asset classes, characterized by a sell-off in equities and a revaluation of the dollar as it becomes a safe haven destination. Notable exceptions to the dollar's strength are the Japanese yen, a defensive currency that has depreciated sharply over the past two years, and the Norwegian krone, which has benefited from rising oil prices.

This geopolitical upheaval is pushing oil prices higher as the market also assesses the possibility of an escalation that would draw Iran into the conflict. After a three-month period of strong oil price appreciation, which had helped to push government bond yields higher and equity yields lower, this situation is hardly encouraging. Indeed, the soft landing story and the associated positive pattern of yields across asset classes are conditional on a continued fall in inflation. The rise in oil, the possibility of it remaining at elevated levels, challenges this environment and may alter the expected direction of monetary policy (in a hawkish direction).

US government bonds, considered a safe haven asset, are trading sideways, a sign of contradictory influences. On the one hand, a sentiment shock generates demand for safety; on the other hand, upward pressure on oil is often associated with higher yields due to its impact on inflation.

Shocks of this type are stagflationary by their very nature and will therefore be particularly difficult to manage for policymakers who have to juggle the growth and inflation they are already struggling with.

We like the dollar for its defensive characteristics against this type of shock and will keep corporate and duration risk low until we see evidence that this episode of deteriorating sentiment and upward rate appreciation has come to an end.

François Rimeu, senior estrategist at La Française AM

How the Israeli-Palestinian conflict will develop is, as of today, extremely uncertain. We do not pretend to know the outcome, but we have identified a number of potential consequences that we will briefly analyze below:

The situation is complicated and arises in a world already plagued by numerous imbalances: climatic, migratory, diplomatic between China and the United States, linked to the conflict between Russia and Ukraine, among others. All these imbalances are likely to make financial markets more volatile in the coming months.

The conflict is unlikely to have a direct impact on oil production, but could have an indirect impact: Hopes that relations between Israel and Saudi Arabia would normalize in the short term have probably disappeared. The US has been working on this for months, which could have led to an increase in oil production by Saudi Arabia early next year. This is unlikely to happen.
The US has reduced the level of sanctions on Iran over the past year, which has led to an increase in Iranian oil production. This increase is estimated at 700,000 barrels/day (source: Bloomberg). Given the links between Iran and Hamas, it is possible that US sanctions could resume, leading to a decline in Tehran's oil exports.

Discussions between US Republicans and Democrats over support for Ukraine have been difficult in recent months and are likely to become even more complicated if the US administration has to 'arbitrate' between support for Israel and Ukraine.

Fortunately, we have not yet reached this level of escalation, but it is always worth remembering that war is by its very nature "inflationary", and more often than not results in higher commodity prices. Thus, the events of the weekend could make the central banks' mission even more difficult.

Benjamin Melman, Global CIO Edmond de Rothschild AM

The events of the weekend in Israel have provoked a rather subdued market reaction this morning, with oil prices up by around 3%, the dollar up by around 0.5%, and a slight flight to quality with a moderate fall in stock markets and long-term interest rates. It is worth remembering that the dramatization of the situation involves non-oil-producing players whose impact on the global economic scene remains limited. The main threat is a regional conflagration, with the risk of a looming Iran-Israel war with far-reaching repercussions.

Iran is not only a major oil producer, but also has the capacity to blockade the Strait of Hormuz, as it has done in the past, and can easily destroy neighboring oil fields. It should be noted that the weekend reaction of Iran's armed wing, Hezbollah, was rather symbolic and does not overtly point to coordinated action by Tehran.

The Israeli prime minister has announced a "long and complex war". No one knows at this point whether it will remain within the scope of operations already seen in the past or whether the shock wave will involve a reaction such that it could lead to an extension of the conflict. The fact that the Israeli government has been particularly weakened on the domestic scene following attempts at constitutional reform rejected by large sections of the population may make its international reaction less predictable.

In this context, the build-up of a risk premium in the markets this morning is logical. At this stage, it does not present any particular opportunity, nor does it call for a review of our asset allocation policy. We are therefore awaiting further developments before taking a position.

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