Early Monday, global financial markets reacted with concern as the Israel-Hamas conflict escalated, sending shockwaves through the stock and oil markets. Stock market futures plunged by over 100 points, and oil prices surged by approximately 3%, reaching $87 a barrel. These developments came in the wake of a surprise attack by the terrorist group Hamas in southern Israel over the weekend, an attack that has tragically claimed more than 1,200 lives to date.
In response to the attack, Israel declared a state of war and launched a substantial military operation in the Gaza Strip, a territory inhabited by 2 million Palestinians. President Joe Biden promptly ordered the deployment of a U.S. naval carrier strike group to the region, reaffirming America’s unwavering support for Israel. While numerous countries condemned the attack on Israel, expressions of solidarity with the Palestinian people emerged in cities worldwide, including New York and other U.S. cities.
Israeli Defense Minister Yoav Gallant ordered a “complete siege” of the Gaza Strip, interrupting the flow of essential supplies such as electricity, food, and fuel from Israel to the region, according to Monday’s news reports.
During a phone call on Sunday, President Biden reassured Israeli Prime Minister Benjamin Netanyahu of the United States’ full support, including military assistance. However, some candidates vying for the GOP presidential nomination sought to link the attack to a recent agreement in which the U.S. promised to release $6 billion in frozen funds to Iran in exchange for the release of five American detainees. Notably, those funds have not yet been released to Iran.
Additionally, the U.S. has been making efforts to strengthen ties between Israel and Saudi Arabia, a move aimed at stabilizing the Middle East but viewed with suspicion by Iran and its allies.
The economic consequences of the attack and Israel’s robust response remain uncertain, although historical trends suggest that the global economy tends to recover from immediate shocks over time. Concerns linger about the potential for the conflict to spread, given Israel’s proximity to hostile neighbors like Syria. There have also been reports suggesting Iranian involvement in the planning of the attack.
“Geopolitical risks are back in focus amid the attack in Israel on Saturday,” remarked James Demmert, Chief Investment Officer at Main Street Research. “We expect short-term volatility in the stock market and oil market as investors digest the heightened tensions in the Middle East.”
The multi-pronged attack, which utilized land, sea, and air assets, including drones and militarized amphibious craft, has raised questions about the effectiveness of Israel’s defense and intelligence systems. The Gaza Strip is known for its robust fortifications and tight security. As of Monday, the combined death toll stood at around 1,200, with 700 casualties being Israelis and residents of other nations, including the U.S., who were attending a music and peace festival. Tragically, about 500 Palestinians have also lost their lives, and there are reports of numerous individuals being taken hostage by the attackers.
These events transpired against the backdrop of existing economic concerns, including rising bond yields and recent stock market declines. Key U.S. inflation data, including the producer price index and consumer price index, is scheduled for release on Wednesday and Thursday, respectively. Economists and market observers will closely monitor these reports to gauge whether they confirm the ongoing trend of disinflation, which has prompted the Federal Reserve to keep interest rates on hold. Inflation has remained in the range of 3%, down from its peak of 9% last summer but still above the Fed’s target of 2%.
Before the weekend’s tragic events, economic indicators had displayed signs of strength. Last week, the Labor Department reported the creation of 336,000 jobs in the previous month, surpassing expectations. Additionally, the third-quarter gross domestic product is estimated at 4.9%, significantly better than earlier forecasts.
However, bond market concerns persist, with yields on certain Treasuries surpassing the 5% mark. The market appears to be acknowledging that interest rates will remain elevated for an extended period. Simultaneously, worries persist about the substantial debt the U.S. must issue to meet its obligations amid ongoing budget negotiations. Some foreign buyers of U.S. debt have scaled back their purchases in recent months.
The resilience of the U.S. economy presents both opportunities and challenges for the Federal Reserve. While the possibility of a “soft landing,” characterized by cooling inflation without a recession, remains plausible, it also implies a greater likelihood of further interest rate hikes and the prospect of protracted higher interest rates.
For businesses, the situation remains volatile. Dan Swan, Co-Leader of the Operations Practice at McKinsey, notes that companies continue to grapple with the aftermath of the COVID-19 pandemic, including disruptions to supply chains. The pandemic prompted many firms to establish alternate supply chains and boost inventories. However, as consumer buying patterns shifted away from goods to services, some, particularly retailers, now find themselves with excess inventory.
The political landscape in Washington adds another layer of complexity, with the recent removal of California Rep. Kevin McCarthy from his position as Speaker of the House leaving the majority Republicans without a leader during a period of global uncertainty. Typically, during times of geopolitical turmoil, other nations flock to purchase U.S. Treasuries, considered the safest investment. However, this influx of capital often results in a stronger U.S. dollar, weakening other economies and making U.S. exports more expensive.