‘Fear trade’: What Israel-Hamas war means for oil prices and financial markets

“There is definitely going to be a fear trade put in place. While in the short term there is no impact directly on supply, it’s obvious how things play out over the next 24 to 48 hours could change that,” Phil Flynn, analyst at Price Futures Group in Chicago, told MarketWatch.

Movements in oil prices, meanwhile, will also serve as a gauge for broader market worries around the conflict, analysts said.

See: Israeli stocks slump in first day of trade since Gaza attack

Hamas, the Iran-backed,Palestinian militant group that controls the Gaza Strip, staged a sweeping attack on southern Israel early Saturday. More than 600 Israelis were confirmed dead, according to Israeli authorities, with more than 2,400 injured. The Palestinian Health Ministry said at least 2,000 Palestinians were killed and around 2,000 injured in Israeli counterstrikes.

Israeli troops on Sunday were engaged in fierce fighting in an effort to retake territory in southern Israel as Hamas launched further barrages of missiles. Israeli citizens and soldiers were captured and are being held hostage in Gaza, according to the Israeli military.

Read: Israel declares war, approves ‘significant’ steps to retaliate after surprise attack by Hamas

“Iran remains a very big wild card and we will be watching how strongly [Israeli] Prime Minister Netanyahu blames Tehran for facilitating these attacks by providing Hamas with weapons and logistical support,” said Helima Croft, head of global commodity strategy at RBC Capital Markets, in a Sunday morning note.

Iranian crude exports have risen in recent years, indicating the Biden administration has adopted a soft approach to sanctions enforcement, Croft said. Some analysts have put Iranian crude production at more than 3 million barrels a day and exports above 2 million barrels a day — the highest levels since the Trump administration pulled the U.S. out of the Iranian nuclear accord in 2018, according to The Wall Street Journal. Sales fell to around 400,000 barrels a day in 2020 as the U.S. reimposed sanctions.

Hedge-fund manager Pierre Andurand, one of the world’s best energy traders, said in a social media post that a large price spike for oil isn’t likely in coming days, but emphasized the market focus on Iran.

“Now, over the last 6 months we have seen a very large increase in Iranian supply due to weak enforcement of sanctions. As Iran is also behind Hamas’ attacks on Israel, there is a good probability that the US administration will start enforcing those sanctions on Iranian oil exports more tightly,” he wrote. “That would further tighten the oil market. Also the probability that this will lead to direct conflict with Iran is not zero.”

Rising Iranian production has helped to fill a global gap between demand and supply. If sanctions are forcefully reapplied, “prices will be substantially higher,” Flynn said.

Meanwhile, The Wall Street Journal late Friday reported that Saudi Arabia had told the White House it would be willing to boost oil production next year if crude prices remained high, as part of an effort aimed at winning goodwill in Congress for a deal that would see the kingdom recognize Israel and in return get a defense agreement with the U.S.

A Saudi production cut of 1 million barrels a day that was implemented in July and recently extended through the end of the year has been given much of the credit for a rally that took global benchmark Brent crude
BRN00,
-0.18%
within a few dollars of the $100-a-barrel threshold before retreating this past week. The U.S. benchmark
CL00,
+0.02%

CL.1,
+0.02%
last week briefly topped $95 a barrel for the first time in 13 months.

In a statement, Saudi Arabia’s foreign ministry called on both sides to halt the escalation and exercise restraint, but also recalled its “repeated warnings of the dangers of the explosion of the situation as a result of the continued occupation, the deprivation of the Palestinian people of their legitimate rights, and the repetition of systematic provocations against its sanctities.”

With the Israeli government vowing an unprecedented response, “it is hard to envision how Saudi normalization talks can run on a parallel track to a ferocious military counter offensive,” said RBC’s Croft.

Beyond oil, much will depend on the potential for the conflict to widen.

Stocks have stumbled, retreating from 2023 highs set in late July, as yields on U.S. Treasurys have jumped. The yield on the 30-year Treasury bond
BX:TMUBMUSD30Y
rose 23.2 basis points last week to end Friday at 4.941%, its highest since Sept. 20, 2007. The 10-year Treasury note yield
BX:TMUBMUSD10Y
topped 4.80% on Oct. 3, its highest since Aug. 8, 2007, and ended the week at 4.783%. Yields and debt prices move opposite each other.

The U.S. bond market will be closed Monday for the Columbus Day and Indigenous People’s Day holiday, while U.S. stock markets will be open.

The S&P 500 index
SPX
rose 0.5% last week, breaking a streak of four straight weekly declines, while the Dow Jones Industrial Average 
DJIA
fell 0.3% and the Nasdaq Composite
COMP
gained 1.6%.

“I think there will be a negative reaction. However, I don’t see a meltdown,” Peter Cardillo, chief market economist at Spartan Capital Securities, told MarketWatch.

Traditional haven plays, including gold
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+0.10%,
the dollar
DXY
and U.S. Treasurys may see a strong move upward, with price gains for Treasurys pulling yields down.

“Geopolitical crises in the Middle East have usually caused oil prices to rise and stock prices to fall,” said economist Ed Yardeni, president of Yardeni Research Inc., in a note. “More often than not, they’ve also tended to be buying opportunities in the stock market.”

The broader market reaction will depend on whether the crisis turns out to be a short-term flare-up or “something much bigger like a war between Israel and Iran,” he said. The latter is unlikely, but tensions between the two are likely to escalate.

“The price of oil may be a good way to assess the likelihood of a broader conflict,” he said.