Geopolitical Tensions between Israel and Iran Cause Volatility in Markets, Longer-Term Risks Rise

Markets have remained relatively calm amidst escalating geopolitical tensions between Israel and Iran. While direct attacks on Israeli territory from Iranian soil were reported over the weekend, limited damage was inflicted and there have been no recorded fatalities at this stage. Although foreign exchange markets are currently pricing in near-term de-escalation following these events, Adarsh Sinha, co-head of Asia FX & Rates Strategy at Bank of America, has warned that the longer-term risk premium may rise due to Iran’s shift from proxy confrontations towards direct ones. Oil prices have also experienced volatility in response to this escalation; while they fell slightly on Monday morning following initial price increases based on expectations for an attack by Iran, their future direction will depend largely upon Israel’s next steps and the level of conflict that ensues. Analysts warn that overall long-term risks and uncertainty have increased as a result of these events, with Holger Schmieding, chief economist at Berenberg Bank describing heightened economic unpredictability stemming from conflict beyond regions currently under pressure – citing Houthis attacks in the Red Sea as an example. Sawicki predicts that Brent prices could potentially exceed $100 per barrel if open war breaks out between Iran and Israel, while a possible blockade of the Strait of Hormuz would have significant implications for oil exports from both countries. The Deutsche Bank analyst team also notes that higher oil prices may lead to inflation remaining sticky in major economies, potentially pushing back interest rate cuts – although it remains unclear whether this will ultimately result in earlier or later trims due to the impact on growth of a geopolitical shock. European equity markets have risen slightly as these events unfolded, with US futures also showing signs of improvement following Friday’s retreat.