Market apathy toward Iran-Israel tensions: Insights on their factors and implications
A looming threat of World War III? Markets seem to think otherwise. With tensions between Iran and Israel escalating, pundits and analysts are making apocalyptic predictions, while the stock markets remain eerily calm. But, why is it so?
Remember when in early 2022, the world trembled at the sight of Russian troops amassing on Ukraine's border? The talk was about a "new world order" and a breakdown of the post-World War 2 consensus. Markets had taken a tumble, with the FTSE 100, Dow Jones, and Dax plunging significantly. But fast-forward a few years, and a different autocratic power is shaking its saber at one of its longstanding adversaries. And yet, the markets seem unfazed.
Israel struck Iranian nuclear sites on June 12th, and the response was underwhelming from financial standpoints. The FTSE 100 and S&P 500 dropped slightly, while the dollar and gold barely moved. Oil prices, while not being ignored, didn't exhibit the dramatic surge one might expect in times of crisis.
So, what's behind this stoic market reaction? One theory is that there's an unspoken understanding between the belligerents. Despite their brutal blows and the targeting of hospitals and strategic infrastructure, there's an agreement not to harm energy infrastructure or crucial trade routes. Iran, the world's 8th-largest oil producer, is still exporting petrochemicals, a critical source of income for Ayatolla Khomeini's regime.
However, Iran could escalate things by blocking the Strait of Hormuz, a narrow stretch of water in the Persian Gulf, a major artery for oil shipments. But analysts doubt Iran's willingness to do so, citing the potential harm to its own exports, as well as the response from the US, China, India, and other Gulf states.
The defining question, however, is the Superpower's response. Neil Wilson, a strategist at Saxo Markets, sees this as the second big question mark hanging over the conflict. President Trump, for now, has opted only to assist Israel in its defense, prevaricating over a more proactive role for days. But if Trump decides to get involved, the markets could be in for a shock.
Stocks have barely budged, given the extreme tail risk of World War III erupting—a situation that has a more-than-zero probability. Investors seem to be holding onto hope that the conflict remains contained, like in the past. But according to Wilson, the sentiment could change if the situation escalates.
Meanwhile, worries are growing about the specter of President Trump changing his mind. Kathleen Brooks, research director at XTB, believes that "news that President Trump would delay any decision on joining Israel's attacks against Iran has boosted the market mood at the end of this week." But the risk is that Trump could alter his stance, just like he did with reciprocal tariffs.
If events do spiral out of control, attention could turn to another significant economic lever: interest rates. At the Bank of England's decision to hold UK interest rates steady at 4.25% on Thursday, the monetary policy committee vowed to "remain sensitive to heightened unpredictability in the economic and geopolitical environment, and will continue to update its assessment of risks to the economy."
However, whether energy price shocks should prompt a tightening of monetary policy is a topic of contention among economists. Some argue that energy price shocks are often transitory, while others worry about secondary effects, where higher energy prices translate to price increases elsewhere in the economy and potentially spark inflation.
For now, investors remain skeptical, maybe holding onto the hope that the world won't change as drastically as some think. But with tensions rising and Trump détente days numbered, one could argue that the world is about to change, just not as per some investors' expectations.
- Despite the escalating conflicts between Iran and Israel, the stock markets, such as the FTSE 100 and S&P 500, have remained surprisingly calm, suggesting an unspoken understanding between the belligerents.
- Some analysts question whether Iran will decisively act on its threats to block the Strait of Hormuz, given the potential harm to its own exports and the possible response from nations like the US, China, India, and other Gulf states.
- The future of the economy may hinge on the actions of President Trump, as his decision to get more involved in the Israel-Iran conflict could have a significant impact on stock markets and other financial sectors, should the situation escalate.
