The Israel-Hamas war has a more than 50% chance of drawing in militant groups from Lebanon or Syria, or producing a direct conflict with Iran — creating more oil disruptions than financial markets currently think.
That’s the view of Matt Gertken, chief geopolitical strategist for Montreal-based BCA Research. He sees a 70% chance of the conflict expanding beyond Gaza in the next 12 months.
Strategists are contemplating the potential ramifications of the conflict on financial markets, even as investors appeared to be relatively calm for now. Traders mostly shook off concerns about the Middle East, with all three major U.S. stock indexes
higher as of Monday morning.
through 30-year Treasury yields
were also higher as investors sold off government debt and abandoned the flight-to-safety trades seen last week. And oil prices declined following last week’s rally, with Brent crude
down 1.2% to slip below $90 a barrel, while the U.S. benchmark
briefly dropped 1%.
Some traders and investors are worried about the possibility of a second wave of U.S. inflation that hasn’t been fully priced by financial markets yet, and which comes at a time when the Federal Reserve is expected to take no action at its Oct. 31-Nov. 1 meeting. With central bankers uncertain about the economic outlook, “a frozen, uncertain Fed risks higher inflation and higher market rates as a result,” according to chief economist Chris Low of FHN Financial in New York.
At Canada’s BCA Research, Gertken sees only a 30% chance that Israel will limit its response to Gaza.
Instead, the strategist points to a 45% chance that the war will expand to include Hezbollah and other militant groups in Lebanon and Syria, producing “a regional war with higher risk of impacting oil, but not necessarily a direct impact.”
In addition, Gertken assigns a 25% likelihood to the scenario that Israel will attack Iran, its assets across the region, or its “core sphere of influence” Iraq — a scenario “that could force Iran to respond militarily, which would include disrupting oil supply to tell the U.S. to restrain Israel.”
Growing instability in the Middle East poses a 31% chance of major oil shocks and investors should prepare to make such shocks their base case over the next 12-24 months, according to BCA Research. Gertken recommends that investors “go long defense stocks and energy versus cyclicals.”
“The key macro concerns from the developments in Israel lie with the threat of upward pressure on oil prices, and how its corresponding effect on core inflation could potentially prompt central bank action,” said Seema Shah, chief global strategist of Principal Asset Management.
“Brent crude prices have not risen materially, but a significant escalation in tensions would likely apply further upward pressure,” Shah wrote in an email on Monday. “While policy makers will likely look through these developments in the near term, higher oil prices can work their way into core inflation and inflation expectations if sustained, demanding central bank action.”
If oil prices rise further and price pressures do re-emerge, expectations of additional monetary action from policy makers could threaten a renewed bond rout, she said. “In light of the situation in Israel, it is prudent for investors to maintain a diversified portfolio across different asset classes, with a particular emphasis on high quality and defensives.”