Although the likelihood of a near-term escalation in the ongoing Israel-Hamas conflict is not high, the risk is «non-negligible», according to Standard Chartered.
Following an attack against Israel led by Hamas on October 7, markets are closely watching for further developments, especially with regard to the direct impact on oil and its knock-on effects.
According to a research report by Standard Chartered, there are two possible scenarios. One scenario is a swift conflict contained within Israel and Gaza without other parties joining. The other scenario involves other major players being drawn in, most notably Iran.
Contained Conflict
The bank noted that markets are predicting that the first scenario will play out due to the lack of incentives to extend the issue outside of the Israel-Gaza border.
«The market reaction suggests investors do not expect an escalation in the conflict ensnaring the broader region and disrupting oil supplies. The reasoning behind this relatively benign outcome: major stakeholders in the Middle East (except for Israel) do not have an incentive to see a broader conflict engulfing the region,» the report said.
«They would rather prefer to confine and resolve the conflict among the involved parties. Such a scenario would keep Middle East oil supplies flowing. History suggests that Middle East conflicts that did not disrupt oil supplies had no lasting impact on oil prices or global financial markets over the medium term.»
Risk-Off Scenario
Nonetheless, the outlook remains uncertain.
«[T]he risk of the alternative scenario is non-negligible in the next few weeks, given the internal political compulsions of Israel’s establishment to act strongly,» the report explained.
«The key is whether Iran or its allies join the conflict. If they do, it could lead to disruption of oil supplies, reigniting inflation concerns, hastening an economic downturn and a sell-off in risk assets. US and European military and diplomatic efforts are aimed at preventing such an escalation in the conflict.»
Investment Strategy
As a result of the latest geopolitical developments, Standard Chartered has increased its conviction for government bonds in developed markets. If the conflict escalates, the bank forecasts outperformance from energy and defense stocks, gold, Swiss francs and the Japanese yen.
«The tragic incidents in Israel and Gaza have cast light on a key geopolitical risk,» the report added. «Markets are likely under-pricing the risk of a near-term escalation, although such conflicts have rarely had a lasting impact on global markets.»
