Once again geopolitical risk is flashing red in markets.
The conflict between Israel and Hamas has put oil traders on alert over fears hostilities will spread in the Middle East and disrupt some of the world’s biggest producers. On Monday Iran, which supports Hamas and backs the Hezbollah armed group in southern Lebanon, warned that an expansion of the war was “approaching the inevitable stage.”
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Though the initial impact on markets after the Oct. 7 attacks by Hamas was modest, significant shifts in oil and gold since then suggest fears and volatility are growing, said Jonas Goltermann, Capital Economics’ deputy chief markets economist.
This past Friday, the price of Brent crude jumped by about 5 per cent in the largest single-day increase since April. Prices steadied today as Washington stepped up efforts to prevent an escalation, with President Joe Biden visiting Israel tomorrow.
Even more surprising was a 3.5 per cent leap in the price of gold, one of the largest single-day advances in recent years, said Goltermann. Demand for this haven was already strong and may strengthen given recent events.
The “geopolitical risk premium” of the Middle East conflict is still much lower than when Russia invaded Ukraine in early 2022, but there is plenty of scope for oil prices to increase if the situation escalates, he said.
“The current restraint in oil prices is highly conditional on the conflict not spilling over more widely,” said Vishnu Varathan, Asia head of economics and strategy for Mizuho Bank Ltd. in Singapore told Bloomberg. A spike to US$100 or $120 is a significant and growing risk, though not a base case, he said.
With U.S. strategic oil reserves at a 40-year low, the conflict threatens to strain an already tight oil market, said Angelo Katsoras of National Bank of Canada.
Iran has a history of targeting oil tankers in the Persian Gulf, a conduit for 20 per cent of the world’s oil exports, he said. Another risk is if the United States tightens sanctions on Iran’s oil exports if it concludes the country is participating in the war.
Saudi Arabia, the world’s largest oil producer, also faces a dilemma. If oil prices spike, increasing output to lower prices could lead to accusations of siding with Israel. However, allowing prices to soar could raise the odds of a global economic slowdown, leading to a collapse in prices, he said.
“The longer the conflict goes on, the greater the potential for oil market disruptions,” said Katsoras.
And oil markets aren’t the only indicators flashing warnings. A risk survey taken by Oxford Economics just days after the Hamas attack suggests the conflict has weakened global business sentiment. The survey found a “notable decline in business expectations for global growth in the year ahead” and higher expectations of a global recession.
Geopolitical risks were already high before the Middle East conflict with the war in Ukraine, tensions over Taiwan and rivalries among the world’s biggest powers, said Katsoras. Western leaders face their own challenges at home, as debt levels soar and interest rates remain at two-decade highs.
“This conflict adds a layer of geopolitical tension to a world already struggling with other challenges,” he said.
