The ongoing war between Israel and Hamas in Gaza is not only a devastating humanitarian crisis - it is also sending ripples through global financial markets, particularly in the oil and foreign exchange sectors. The conflict, now in its sixth month, has resulted in thousands of deaths, widespread destruction, and a looming famine in Gaza. But its impacts are being felt far beyond the borders of the embattled Palestinian enclave.
One of the most direct effects has been on global oil prices. Crude oil benchmarks like Brent have surged to their highest levels in over a year, briefly topping $89 per barrel, as the Gaza fighting has escalated supply concerns in an already tight market. While neither Israel nor Palestine are major oil producers themselves, the risk is that the conflict could draw in neighboring states and disrupt supply flows from the Middle East.Â
Iran, which backs Hamas, has already vowed revenge against Israel for an airstrike on its consular building in Syria. Any direct confrontation between Israel and Iran, a major oil producer, could seriously jeopardize global oil supplies. Even without their direct involvement, the Syria strike and intensifying Israel-Hamas conflict is raising the geopolitical risk premium built into oil prices.
Supply risks are being compounded by actual disruptions resulting from attacks within Russia, the world's second largest oil exporter after Saudi Arabia. Ukraine has launched a series of drone strikes on Russian oil refineries and energy infrastructure, aiming to choke off the oil revenue that is funding Russia's invasion. Russian output is down nearly 1 million barrels per day as a result.
Between the Gaza crisis stoking Middle East tensions and the Russia-Ukraine war disrupting actual supply, oil markets are on edge and prices are being bid up. While good news for oil exporters, rising energy costs act as a tax on consumers and businesses in oil-importing nations, compounding the economic damage from high inflation and interest rates. The surge in oil is therefore concerning for the global economic outlook.
The Gaza war is also making waves in currency markets, particularly for the shekel. With Israel's economy on a war footing and domestic unrest rising, the shekel has come under heavy pressure. While the Bank of Israel has so far held benchmark rates steady at 2.25%, it may be forced to hike more aggressively to defend the currency if the conflict worsens. This is weighing on the shekel, which has fallen over 4% against the dollar so far this year.Â
In contrast, some currencies like the Swiss franc and Japanese yen are benefiting from safe-haven demand driven by the Gaza crisis and other geopolitical risks. The US dollar is also gaining broader strength as the economic outlook darkens and hopes fade for imminent Federal Reserve rate cuts. This is keeping rival currencies like the euro and British pound on their back foot despite expectations the ECB and BoE will also be cutting rates later this year.
Major currency pairs like EUR/USD, GBP/USD and USD/JPY are experiencing heightened volatility as a result, creating both risks and opportunities for forex traders. Navigating the complex web of geopolitical, economic and policy factors driving exchange rates has rarely been more challenging. While events like the Gaza war introduce a lot of noise and near-term volatility, the underlying economic fundamentals and monetary policy paths remain the key drivers of currency trends.
For the oil-linked Canadian dollar and Australian dollar, the crude rally resulting from Gaza tensions has provided some support, helping offset domestic economic headwinds. The RBA just paused its rate hike cycle as the economy cools. Continued strength in energy exports will be key to underpinning these oil-sensitive currencies going forward.
The Gaza war, inflationary oil shock, and interest rate uncertainty have also weighed heavily on global equity markets. After strong gains to start the year, stock indices have retreated in recent days as optimism around a soft economic landing fades. High energy costs and rates could compound the slowdown, further denting corporate earnings. Hopes for Fed rate cuts later in 2023 - a key driver of the recent rally - are also being dialed back. This has pushed the S&P 500 back below the 5000 level.
While not the primary driver, the Gaza conflict is exacerbating a challenging fundamental backdrop for stocks. Historically, wars in the Middle East have often presaged equity bear markets, as they disrupt the oil supplies that are the lifeblood of the global economy. The 1973 Arab-Israeli War, 1990 Gulf War and 2003 Iraq War were all followed by major stock downturns.Â
Although the Hamas attack has devastated the Israeli economy and impacted certain sectors like defense and tourism, the overall impact on global equities has been limited so far. Investors may grow more concerned, however, if the conflict starts to seriously threaten oil supplies from major producers.
Perhaps the only asset class clearly benefiting from the Gaza crisis is gold. The precious metal has surged above $2,260 per ounce to hit new all-time highs in recent days, bolstered by its appeal as a safe haven in times of geopolitical turmoil. While the prospect of lower interest rates is also supporting gold at the margin, intensifying Mideast tensions, elevated inflation and general uncertainty are the primary drivers of the current rally.
Gold continues to hold its value in today's challenging environment of lackluster growth, high inflation and rising geopolitical risks. While gold is often seen as an inflation hedge, it's really more of a crisis hedge. And the Gaza war is the latest in a series of escalating crises, both geopolitical and economic, driving demand for gold as a store of value outside the traditional financial system. With no end in sight to the Israel-Hamas fighting or the larger forces of deglobalization and conflict it represents, the outlook for gold remains constructive.
In conclusion, while the immediate human toll of the Gaza war has been tragically high, the conflict is also having an outsized impact on global markets - particularly oil, currencies and gold. By driving up energy costs it is compounding the inflationary pressures and growth headwinds already facing the world economy. The associated risks are weighing on certain assets like stocks and oil-importing currencies, while bolstering safe havens like the dollar and gold.
For investors and traders, the key is to look through any short-term noise and remain focused on the bigger picture. Geopolitical flare-ups tend to generate a lot of heat in the moment but rarely change the larger economic trends. The path of growth, inflation and central bank policy will continue to be the main drivers of asset prices in the medium-term. Still, by introducing volatility and uncertainty into already jittery markets, conflicts like the tragic war in Gaza can be the spark that lights a financial crisis. Vigilance is warranted.