Implications for global investors of the Israel-Hamas war

Key takeaways

• Market reaction to the conflict has been limited to small moves in haven assets; any future financial impact depends on escalation risks and potential changes to crude oil supply
• We model oil market scenarios, and do not expect a material impact on oil production. We see crude prices trading around USD 90 per barrel in the coming months
• Possible disruptions to trade flows would have far-reaching consequences, including any rise in tensions around the Strait of Hormuz
• As long as the conflict remains localised, we maintain a cautious investment strategy, preferring quality fixed income and the USD, and keep a neutral stance on equities and gold.

Future market impact of the tragic events in Israel and Gaza will largely depend on whether the conflict escalates, as well as any impact it has on global oil production. Looking beyond the conflict’s horrific human toll, financial assets have not, so far, responded with alarm to events since 7 October, but the geopolitical volatility warrants close monitoring.

The reaction in traditional haven assets, typically the first to jump in response to major geopolitical crises, has been varied. Ten-year US Treasury bond yields have risen marginally. The US dollar remains largely unchanged against a basket of currencies, slightly declining against the Swiss franc; the latter has risen to some extent against the euro. Gold showed a more meaningful rise of around 8% in USD.

For financial markets, what happens next depends on whether the conflict escalates significantly and if major disruptions occur in the Middle East’s supply of energy to the rest of the world. Our expectation is that the conflict will remain localised, but the risk of an escalation remains high and We continue to monitor these risks and events as they unfold.

Regional diplomacy, including the process of normalising relations between Israel and Arab states and any expansion of the Abraham Accords, looks frozen for now. For Israel’s economy, disruptions in consumer spending, international trade, and the labour market should trigger a contraction of around 1.0-1.5%¹ in the fourth quarter. Nevertheless, the country can maintain its financial market stability with foreign reserves of USD 199 billion, or 38% of its 2022 nominal GDP. Its robust external accounts are the result of two decades of current account surpluses and disciplined macroeconomic policy.

Regional economies and equity markets will of course be affected by events on the ground. Israel’s USD 490 billion economy is larger than its immediate neighbours: Egypt’s gross domestic product (GDP) in 2021 was USD 404 billion, Jordan’s USD 45 billion, Lebanon’s USD 23 billion and Syria’s USD 11 billion. A tragic recent history of violence and conflict in the region has kept global trade and foreign investment flows at bay in recent decades, limiting the impact on global markets. As the US dollar value of the combined GDP of Israel, Egypt, Jordan, Lebanon, and Syria is approximately USD 1.1 trillion, or about 4% of the US economy, the global macroeconomic impact should remain limited.

Oil scenarios

The impact on oil prices to date has been more direct than the impact on haven assets, with a roughly 8% gain leaving Brent crude prices below their late-September high. Our base case remains that the conflict should not change the status-quo in the region’s oil production. We see pressures keeping prices around USD 90 per barrel in the coming months, or slightly higher. This is because global supplies are tight, inventories low, and demand resilient – with a slowdown in developed markets offset by robust emerging market demand, including from China.

Still, there are scenarios in which oil production could be affected, including any retaliatory production cuts and/or embargoes by oil producing states, as in 1973. We see this as unlikely. Such gestures would signal an overhaul of the region’s strategic order. More importantly, an additional large supply side shock for crude oil and natural gas would incentivise US shale producers to expand their capacities and market share, which may only partially offset the initial volume shock, while accelerating the global demand shift towards renewable energy and electric vehicles.

Another potential concern is greater scrutiny and US-led sanctions on Iranian oil supply. This supply has been rising steadily in 2023, and now exceeds 3 million barrels per day (mbpd). Concerns around this oil source are likely the main reason behind the upward shift in crude oil futures curves since 6 October. However, even under a scenario where 0.5-1.0 mbpd of Iranian oil supply is removed, we would expect Saudi Arabia or the United Arab Emirates, which have spare capacity of around 4 mbpd and 0.8 mbpd respectively, to cover the shortfall, stabilising oil prices and reducing the risk of lasting demand destruction.

Read also: Oil and beyond – the Gulf economies’ path to new horizons

A higher-stakes escalation might involve Iran disrupting trade through the Strait of Hormuz, through which around one fifth of the world’s oil (roughly 21 mbpd), most of Saudi Arabia’s crude exports and one third of global liquefied natural gas (LNG) are shipped. In 2019, oil tankers were attacked as they passed through the 55 kilometre-narrow channel that separates Iran from the Arabian Peninsula channel, raising tensions and triggering price spikes.

This is not the only potential logistical choke point. Egypt has the potential for instability around presidential elections planned for December, perhaps if a refugee crisis on its border takes a political toll. The Suez Canal linking the Red Sea and Mediterranean, which carries around 12% of global trade volumes and 30% of global container traffic, remains vulnerable.