Markets weigh risk of retaliation after Iran's massive attack on Israel

Markets weigh risk of retaliation after Iran's massive attack on Israel

Financial markets will face the new week worried about geopolitics, with much at stake over whether Iran's unprecedented weekend attack on Israel triggers rounds of retaliation.

The escalation of the Middle East crisis, already roiled by inflation and the prospect of higher interest rates for longereither, will inject new volatility when trading resumes.

When Hamas attacked Israel in October, the biggest fear of many market participants was that Iran would become involved in the fighting. Now, as the conflict spreads, many say oil could surpass $100 a barrel and they expect a flight towards Treasury bonds, gold and the dollar, along with new stock market losses.

Nerves may yet be tempered by Iran's statement that “the matter can be closed” and by a report that President Joe Biden told Israeli Prime Minister Benjamin Netanyahu that the US will not support an Israeli counterattack against Iran.

“The natural reaction of investors is to look for safe haven assets at times like this,” said Patrick Armstrong, chief investment officer at Plurimi Wealth LLP. “Reactions will depend to some extent on Israel's response. If Israel does not escalate from here, it may be an opportunity to buy risk assets at lower prices“.

Bitcoin offered early insight into market sentiment. The token sank almost 9% after Saturday's attacksto recover on Sunday and trade near US$64,000.

Stock markets in Israel, Saudi Arabia and Qatar posted moderate losses in a context of low trading volume.

“Middle East markets opened relatively calmly following Iran's attack, which was perceived as a measured retaliation rather than an attempted escalation,” said Emre Akcakmak, senior consultant at East Capital in Dubai. “However, Market impact could spread beyond the Middle East due to spillover effects on oil and energy priceswhich could influence the outlook for global inflation.”

Investors will now weigh the risk of a strike-counter-strike cycle, with many looking to oil as a guide for how to respond. Brent crude oil is already up almost 20% this year and is trading above $90 a barrel.

Although the conflict in the Middle East has not yet had any impact on production, attacks by the Houthis in the Red Sea, supported by Iran, have disrupted shipping. Operators fear, above all, that the escalation of the conflict interrupts oil tanker shipments from the Persian Gulf through the Strait of Hormuz.

Concern about unrest in the region has also filtered into global markets. The S&P 500 has just recorded its biggest weekly drop since Octoberdue to higher than expected inflation and disappointing bank results.