Markets Weigh Repeat Cycle Risks After Iran Attacks Israel

(Bloomberg) - Financial markets will be jittery over geopolitics in the new week, largely depending on whether Iran's unprecedented weekend strike on Israel triggers rounds of retaliation.

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With investors already reeling from persistent inflation and the prospect of higher and longer interest rates, the escalation of the Middle East crisis is bound to bring new volatility when trading resumes.

When Hamas attacked Israel in October, the biggest fear of many market participants was that Iran would end up in the crossfire. Now, as the storm widens, with many saying oil could go over $100 a barrel, expect a rush for Treasuries, gold and the dollar, as well as further declines in the stock market.

Friday's market risk aversion in anticipation of a blow, Iran's statement that "the matter can be considered closed" and reports that the US President of Arms, Joe Biden, told Israeli Prime Minister of Agriculture, Benjamin Netanya, that the United States would not support Israel's counterattack against Iran, are factors that may still ease investors' nervousness.

"The natural reaction of investors in times like these is to look for safe-haven assets," said Patrick Armstrong, chief investment officer at Plurimi Wealth LLP." Investors' reaction will depend in part on Israel's response. If Israel doesn't get a promotion on this, it may provide an opportunity to buy risky assets at a lower price."

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Bitcoin reveals market sentiment ahead of time. After Saturday's attack, Bitcoin fell nearly 9% before rebounding on Sunday to trade near the $64,000 mark.

Saudi Arabian and Qatari stocks fell slightly on thin trading volumes. Israel's benchmark fluctuated between gains and losses at least nine times before ending with a modest gain.

"The Middle East markets have had a relatively quiet start following the Iranian attack, which is seen as a measured repetition rather than an attempted escalation," said Emre Akcakmak, Senior Advisor at East Capital in Dubai. However, due to the secondary impact on oil and energy prices, the market impact could extend beyond the Middle East, potentially affecting the global inflation outlook.

Investors will now weigh the risks of a cycle of strikes and counter-strikes, with many using oil as a guide on how to respond. Brent crude has risen nearly 20% this year, trading above $90 a barrel.

Although the conflict in the Middle East has not yet had any impact on production, the attacks by Iranian-backed militia in the Red Sea have already disrupted shipping. Traders are mostly concerned that the expansion of the conflict may disrupt the transportation of oil tankers from the Persian Gulf through the Strait of Hormuz.

Israel's War Cabinet Discusses Response to Iranian Attack : TOPLive

Worries about turmoil in the region are also spreading across global markets. The Standard & Poor's 500 Index posted its biggest one-week drop since October as higher-than-expected inflation and bank earnings disappointed.

In the bond market, traders will be weighing the risk that more expensive energy bills could exacerbate inflation concerns. While Treasuries tend to benefit in times of uncertainty, the threat of high interest rates could limit their strength. U.S. stock and bond futures will open at 6 p.m. New York time on Sunday.

Meanwhile, gold has been on a strong run, rising 13% so far this year to a record above $2,400 per ounce. Investors are also looking for stabilization in the U.S. dollar. The U.S. dollar index rose 1.3% last week, its best performance since the end of 2022.

Here's what investors and analysts are saying:

Erik Meyersson, Premier Emerging Markets Strategist at SEB:

"Our oil analysts believe that oil prices have not shown much sign of a geopolitical risk premium so far. We expect this to reflect the market's view that the risk of an escalation in the situation is low so far. This balance could be tested if Iran and Israel continue to attack each other.

Gonzalo Lardies, senior equity fund manager at Andbank:

"A new environment of uncertainty is developing, but the market has already partially priced in this situation on Friday, so the impact should not be significant if the situation does not worsen. The risk is if the situation escalates and spreads across the region.

Alfonso Benito, Matteo at Dunas Capital

"Considering how Israel defends its air defense shield, I don't expect a big drop. We should see defense companies go up, oil go up, natural gas go up, and airlines may go down. Bonds will go up, but not too much in my opinion. Investors can use this opportunity to partially correct the gains of recent months.

Joachim Klement, a strategist at Liberum:

"The reaction will largely depend on how Israel reacts today and whether the United States can find a way to restrain Benjamin Netanya.

"In the coming days, equities will focus on geopolitics rather than central bank action or the strong US economy. As a result, we expect the rally to be stalled until the situation in Iran and Israel calms down and becomes clearer. If a shooting war eventually breaks out between Israel and Iran, then the rally will be stalled for a longer period of time.

Mark Matthews, a strategist at Bank Julius Baer in Singapore, said:

"The good thing is that Iran did issue a warning before the attack. Military analysts say the attack was carried out in a way that minimized casualties. I don't see why this would lead to a further drop in Fed interest rate expectations or a huge increase in oil prices. Both Iran and the US are trying to defuse this crisis. The key is Israel's response, and Iran's response. If Israel takes a step down, and then Iran takes an even step down, then it's over.

Geoff Yu, London-based senior strategist for Europe, Middle East and Africa markets at BNY Mellon:

"Even with the recent buying spree following the release of the CPI data, there is still room for further accumulation in the USD. Our clients are still overweight some of the higher loaded currencies such as the Euro, Canadian Dollar and Mexican Peso, so we will be watching the rotation in the US Dollar.

Neil Shearing, a mat economist at Capital Economics in London, said:

"Our sense is that the events in the Middle East will add to the reasons for the Fed to be more cautious about cutting rates, but will not prevent it from doing so altogether. We expect the Fed to take its first action in September. Assuming energy prices don't spike in the next month or so, we think both the ECB and BoE will cut rates in June.

-Written with the help of Macarena Muñoz, Allegra Catelli, Alice Gledhill and Anthony Di Paola.

(Full text updated with prices and citations added).

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