Israel conflict: What investors need to know

What’s happened?

The attacks on Israeli territory and citizens and the subsequent retaliatory attacks have the potential to generate significant instability in the Middle East. The situation is very fluid and future developments remain to be seen.

However, there are potentially negative implications for Israel and other economies in the region and for the global outlook through rising oil prices and potential disruptions to trade and travel. General volatility in global markets is a clear risk but specific market outcomes are very uncertain at this stage.

Market reaction

The attacks had an immediate effect on the Israeli shekel, which fell to a near-eight year low on Monday, dropping by more than 3% at one point. That was despite the Bank of Israel announcing US$30bn of foreign exchange liquidity and US$15bn in swaps to protect the currency.

However, the response in wider markets has been only moderate so far. Admittedly developments have added to broader developments shaping interest rate expectations and have offset initially weaker equity markets reactions. Global oil benchmark prices have increased in part reflecting concerns about possible disruptions in oil markets. Assets perceived as safe havens, such as gold, government bonds and the US dollar, also gained ground in the immediate aftermath of the attacks.

Insofar as market reactions remain in this order of magnitude, the risks of these events having a broader impact on the global economy would be limited. But developments are clearly very fluid and require close monitoring.

AXA IM’s view

Head of Macro Research, David Page:

The attacks have increased geopolitical tensions, added to headwinds to global growth and raised risks of far greater disruption over the weeks and months ahead.

The risk for the global economy would come from a broadening of tensions and an escalation of conflict. This could result from several potential future developments with the bilateral, regional and broader relationships likely key to shaping the outlook.

Iran’s position will be pivotal in terms of influencing Israel’s reactions and the broader international response, including from the US and Saudi Arabia. Saudi Arabia’s response will be very important, particularly over its stewardship of oil markets - for now it is still limiting oil production, in coordination with Russia, to support oil prices. A more nuanced and diverse reaction amidst neighbouring states towards Israel now explains why oil markets have not initially seen a 1970s style oil shock so far. However, events need to be monitored closely.

The path that these governments, and other important regional players, follow will in turn be governed by the Israeli response to these attacks in terms of breadth, severity and duration.

Certainly, scenarios exist that could see a broad escalation of tensions that would be increasingly disruptive to global economic activity and markets.

CIO of Core Investments, Chris Iggo:

Markets have been roiled in recent weeks by the rise in interest rate expectations, especially in the US. It is not clear that events in the Middle East will have an impact on monetary policy in Europe and the US. However, expectations of official interest rates now being at a peak could be reinforced as a result of increased global political tensions.

Typically, uncertainty tends to lead to ‘safe haven’ buying which, under certain scenarios, could see some reversal in the recent increase in government bond yields. If there is a sustained increase in global oil prices, investors will again need to contemplate the impact on growth and inflation. This may exacerbate existing concerns about the outlook and create some volatility in equity and credit markets.

The debt of several Middle Eastern issuers has already been impacted. Israel itself faces pressures on its currency and its foreign reserves. However, it holds significant foreign exchange reserves, as do other debt issuers in the Gulf region. Developments in Egypt, a significant issuer in external debt markets, are to be watched closely, as refugees fleeing the conflict may put a strain on its economy, with financial assistance from the IMF becoming more critical. Turkey and Qatar have so far called for de-escalation and put themselves forward as potential mediators in the crisis, which has sounded a reassuring tone to markets.

On the equity side, Israel is quite significant in being a home to research and development (R&D) units for several companies across the technology space, including among others, semiconductor, software and cybersecurity firms.

While Israel is classified as a developed country and represents 0.17% of the MSCI All Country World Index, it accounts for circa 2% of the broadly used Technology index (MSCI World IT). Any escalation or long-lasting conflict could cause disruption for businesses with operations and R&D on the ground in Israel.

What’s next?

A material escalation of events could produce a further stagflationary shock to the global economy.

A surge in oil prices would be most felt in high oil importing countries and those with relatively low fuel duties, focusing pressure on several emerging market economies and the US.

Meanwhile elevated uncertainty around developments would also weigh on investment decisions, most particularly in the region, but more broadly as businesses further assessed risks and uncertainties.

The combined effects would likely slow economic growth further and leave inflation higher for longer. This would be unwelcome for international central banks that have already struggled to mitigate shocks related to the pandemic and the Ukraine war.

At the extreme, unfolding developments could slow economic activity materially, but also risk raising both headline and core inflation. Yet for now, such an outlook remains a risk case and we remain vigilant to developments in a fluid emerging situation.