Implications of the Israel-Gaza War for financial markets

Executive summary:

• The main risk to the global economy and asset prices from the Hamas attack on Israel is through oil markets
• At this time, our baseline expectation is that market impacts from this conflict will be modest and transitory in nature

On behalf of Russell Investments, our hearts go out to all of those impacted by the developing tragedy in the Middle East. In this article we’ve summarized some of the key takeaways from an emergency meeting held by our investment leadership team on Sunday, Oct. 8.

Our view

The main risk for the global economy and asset prices is through oil markets—with a broadening out of the military engagement into Lebanon or—much more significantly—into Iran being key escalation channels to monitor in the weeks ahead.   

Directionally, higher oil prices would act as a tax on consumer spending power and would extend the inflation overshoot that central bankers are battling across developed markets.

However, the parallels some observers have made toward the 1973 Arab-Israeli War and the subsequent OPEC oil embargo of the United States appear overblown at this stage. Consider that:

• Crude oil prices roughly tripled in the period from 1973-1975, with supply shortages and rationing amplifying the damages to the U.S. and global economy. While it is far too early to make a definitive statement about how far the current conflict might escalate, West Texas Intermediate (WTI) crude oil prices are only up roughly 4% in trading as of Monday morning Pacific time.
• Markets tend to focus on how events impact the United States business cycle. In this regard it is important to contextualize how much the U.S. economy has changed in the last 50 years. The U.S. is now the largest oil producer in the world, the U.S. is now a net exporter of oil, and the U.S. consumer spends a much smaller share of its disposable income on energy than it did in the 1970s. Put simply, the U.S. economy is not as exposed to energy shocks as it used to be.
• Unlike the invasion of Ukraine in 2022, which simultaneously impacted crude oil, natural gas and agricultural markets, a conflict in the Middle East is likely to disrupt oil markets more narrowly.

We have not made any immediate changes to our outlook or portfolio positioning in response to the conflict. While we are attentive to a range of possible geopolitical scenarios, our baseline expectation is that the effects from this conflict onto markets are likely to be more modest and transitory in nature.

Initial market response

So far, market dynamics look consistent with this view. Trading on Monday morning, as of 8 a.m. Pacific time, indicated a modest flight-to-safety trade:

• WTI crude oil prices rose 4% to $86 per barrel
• The S&P 500 Index fell 0.5%
• The trade-weighted U.S. dollar appreciated 0.2%
• The 10-year U.S. Treasury yield fell 10 basis points to 4.7% in futures trading on Sunday night before being closed Monday for the U.S. holiday. 10-year UK Gilt and German Bund yields also declined moderately on Monday.