Escalating Tensions—Globally and on Wall Street

PUBLISHED OCTOBER, 2023

After the deadly attacks over the Yom Kippur holiday, Israel’s goal regarding Hamas has shifted from containment to eradication. Gaza is now sealed off. Hamas and the Israeli Defense Forces are exchanging rocket fire. But Israel is also mobilizing troops in preparation for a large-scale ground assault. 

The two greatest risks for regional escalation now are with Egypt, which shares a border with Gaza, and with Hezbollah, to Israel’s north. The Egyptian border is sealed, but Gaza civilians are eager to cross it to escape the escalating conflict, suggesting it could be sucked into the humanitarian response. 

Meanwhile, on the Lebanese border, Israel has exchanged rocket fire with Hezbollah, which, like Hamas, acts like an Iranian-funded terrorist organization. Hezbollah is well-funded and well-armed and is the most likely to be pulled into the conflict if anyone is, according to reports from The Wall Street Journal. 

The massive surprise attack on Israel by Hamas adds to an already fluid set of potentially destabilizing scenarios around the globe that only make investing in U.S.-based assets that much more attractive. This was an unprecedented attack that will result in a major military escalation with regional implications, beginning with how nations will view the long reach of Iran as a sponsor of terror in that part of the world. 

One thing is certain: the long-running Arab/Israeli conflict just got hotter.

Gita Gopinathm, first deputy managing director for the International Monetary Fund, told Bloomberg News that oil prices were the most likely way the broader world would feel any economic impact from the conflict. It is still very early, she said, but if oil prices rise $10, it is likely to increase global inflation by 0.4 percentage points.

Crude oil and gold futures quickly bumped higher in response to the unprovoked Hamas attack on Israel. Wall Street analysts generally expected a “knee-jerk surge” in crude prices but limited gains thereafter. That is, provided the conflict does not expand into a regional war—which is far from certain since the fighting is on the doorstep of an important oil-producing and exporting region. 

While oil fundamentals have not yet changed since these attacks, it does not mean they won’t. If Iranian involvement in the attack is affirmed, the U.S. could step up sanctions on Iran’s crude exports. If Israel were to strike any Iranian infrastructure, crude oil prices would spike immediately.

The Biden administration had hoped to broker a Saudi-Israel deal in the next six months, but the escalating situation in Israel has likely dashed hopes for normalized relations between the countries. Saudi Arabia is not expected to slow oil production, although there is a risk of the Saudis’ unwinding their additional voluntary supply. The recent surprise attack also leaves Israel unlikely to make any concessions to the Palestinians that the Saudi government might have sought.

In general, bond markets tend to punish countries with large budget deficits and weak leadership. Alas, that is where we also stand now in the U.S. (as profiled in a recent Wall Street Journal article entitled, “Rising Interest Rates Mean Deficits Finally Matter.”) The article makes the point that it is very odd for Treasury bond yields to rise when inflation is cooling, and the U.S. economy is growing. The likely culprit? Rising deficits that must be financed by our government.