Geopolitical events such as the deadly Hamas attack on Israel can result in gut-wrenching human impacts. The purpose of this update is to assess the potential market and economic implications of the attack on Israel. But we first pause to recognize and acknowledge the suffering, pain and devastation of war.
The role of markets, while not meant to diminish the human tragedy of events, is to assess the economic impact. The market so far has considered the conflict relatively contained with limited broader impact. Equities are up while bonds yields are down. A flight to the safety of U.S. Treasury markets is common when uncertainty and volatility increase, but the move lower in yields in the days following the attack was at least as much about the unrelated and expected end of Federal Reserve rates increases and concerns over the path of the economy. For example, yields shot up later this week after the Consumer Price Index release showed signs that high inflation is proving stickier than expected.
Historically, geopolitical events can cause volatility, but the potential impacts are quickly priced in. Broader economic and earnings trends then drive markets.
For example, the outbreak of war in Ukraine in early 2022 initially sparked a selloff in equity markets and a rally lower in bond yields. But within a few weeks, equities had recovered from the initial loss and bond yields rose. Prices for Brent Crude oil, the global benchmark price index, increased and were volatile as embargoes and restrictions on Russian oil took effect. But global markets adjusted. Oil supply chains were reconfigured, and oil prices fell, ending the year little changed. Ultimately, markets and the economy in 2022 were not driven by the Ukraine war, but by the Fed’s aggressive interest rate increases, the path of inflation, and the continuing impact of massive stimulus in the wake of the COVID pandemic.
Looking at significant geopolitical events back to World War II, the median duration of selloffs in the S&P 500 Index has been around two weeks with a decline of more than 6% before recovering the loss within a bit more than two weeks.
Markets now seem to be following a similar path, with the conflict in Israel and Gaza having minimal market impact. Risks remain, certainly, including a broader conflict in the Mideast, possibly involving Iran on other countries. However, news reports indicate that U.S. intelligence at this early juncture doubts Iran played a direct role in helping with the Hamas attack.
Should the conflict widen, oil prices likely would increase, fueling inflation at a time when inflation has been falling. While the Fed focuses on inflation that excludes volatile energy and food prices, higher energy prices ultimately seep into other categories and, importantly, can financially stretch consumers. We believe markets in this scenario would react negatively, with equities falling and volatility in interest rates rising as greater inflationary risks pressure yields higher while investors buy Treasuries in a flight to safety and concerns about growth push yields lower. But as in the past, markets would adjust and discount the new risks, returning focus to the economy and earnings.
Geopolitically, the current conflict draws the U.S. focus back to the Middle East at a time when the country was pivoting its attention increasingly toward Asia—and in particular, the strategic competition with China—after decades of U.S. involvement in Iraq and Afghanistan.
The future always is uncertain. Unexpected events flare continually. Markets assess them and work to discount the financial impact by adjusting prices. In the case of the current war, market pricing reflects expectations that the conflict between Hamas and Israel will remain contained. The risks of a broader war are not priced in, and if one occurs, we expect markets to rapidly discount the impact and return to focus on earnings and the economy.