Navigating Rates

Israel-Iran: what next?

Iran’s direct action on Israel over the weekend has led to fears of further escalation. But in the absence of a full-blown crisis in the region – which is not our base case – we think the impact on financial markets will be contained.

Key takeaways

  • Iran’s attack on Israel has raised fears of a wider conflict but a broader war in the region is not our base case scenario.
  • We see “reassuring” indications that any response from Israel could at least be measured and the US, Israel’s most important ally, has said it won’t participate in any retaliation.
  • Commodity markets may see the most direct transmission of the tensions, and we expect prices for oil and its derivatives to spike even higher in coming weeks.
  • The conflict may help create entry points in equity markets, while US Treasuries may also benefit from their safe-haven characteristics in times of geopolitical tension.

An Iranian strike on Israel would have been unthinkable six months ago. But the weekend’s attack was a consequence of months of bloodshed that have hardened old battlelines in the Middle East. The fear is that Iran’s action could lead to a further dangerous escalation in the region, justifying an increase in the probability of a full-blown crisis. But there are some “reassuring” indications that any retaliation could at least be measured, and we expect both sides to step back from the brink of war:

  • Iran’s mission to the United Nations announced after the strike that “the matter can be deemed concluded”, showing that Tehran may try to calm the situation in the coming months.
  • Both damage to US and Israeli interests and human casualties were very limited, at least according to first reports, suggesting that the road to a potential de-escalation can be found.
  • Israel and its allies seem to have managed to shut down a large majority of the incoming drones and missiles, which should deter Tehran from a renewed attack. Israel’s success in countering the multi-wave attack will be an important lesson learned.
  • With Israel and Iran approximately 1,000km apart, an Israeli air strike is difficult without the support of its allies and neighbours. Iran also seems to have avoided using its more lethal ballistic missiles.
Given this backdrop, we see some potentially important though contained impacts for the global situation and financial markets:
Geopolitics: global ripples but not a broader war

Iran’s attack will further complicate President Biden’s pre-election situation. To shore up support from the US Muslim electorate he leant on Israeli Prime Minister Benjamin Netanyahu to open food aid to Gaza. But the attack from Iran will force him to reaffirm US commitment to Israel.

Russia may benefit as global attention moves from Ukraine to the Middle East, stretching Western military support. Higher oil prices will also help President Vladimir Putin stabilise the Russian budget.

China has in recent years become increasingly assertive in the region, a position it will want to further reaffirm given fast-moving events in the region. But it also needs to ensure things do not get out of control, as it is itself fighting economic issues and needs cheap oil and open commercial routes.

Commodities: oil provides a hedge for turmoil and gold should benefit

Amid tensions in the Middle East, Brent crude had already risen to over USD 90 a barrel, and we expect prices for oil and its derivatives to spike even higher in coming weeks. This fits well with our long position on the commodity complex. Our fundamental view remains constructive as we think oil offers a good hedge against renewed inflationary risks while profiting from the Chinese recovery and solid US economy.

After a strong rally recently, also triggered by geopolitical tensions, gold should continue to profit from its status as a diversifier and safe haven, with emerging markets investors buying into the yellow metal. An exogenous increase in headline inflation coupled with flights into safe haven Treasuries could support gold, as real interest rates will trend lower.

The only risky factor is how the US dollar responds to the crisis: as a safe haven, the dollar tends to profit from such situations, which would be a negative for commodities.

Inflation: price pressures should remain under control

Further escalation could complicate central banks’ effort to bring inflation under control as higher oil prices creep into core inflation. Nevertheless, we believe that unless we have a full blow-up of the regional crisis, the impact should remain under control.

In the US, the key issue is excess demand while its large domestic oil production allows it to be more immune to external shocks like the present one. On the contrary, price rises could be more broadly felt in Europe at a time when the economy just started reaccelerating, especially as gas prices have recently crept up following Russia’s attacks on Ukrainian facilities.

All in all, after the recent rise in US Treasury yields, the US Federal Reserve (Fed) could move back to its “natural” cautious stance in cases of uncertainties and maintain its pace to lower interest rates in the second half of the year.

Financial markets: potential entry points may emerge

Equity markets remain fundamentally solid thanks to better-than-expected economic data and solid earnings. In the medium term, we therefore remain constructive on stock indices, and we think short-term corrections might offer good entry or re-entry points.

However, we are also fully aware that short-term momentum was already slower in April before Iran’s strike, as unexpectedly high inflation data in the US led to higher-for-longer interest rate expectations, with US Treasury yields ending last week above 4.5%.

In this environment, higher oil prices could – largely for psychological reasons – exacerbate fears of longer-term inflation stickiness and receding chances of central bank rate cuts.

Equity positioning and sentiment has grown increasingly positive in recent months without straying into bubble territory. Fallout from the weekend’s events may help limit any market exuberance. Even before this latest twist in the Middle East conflict we were anticipating further volatility in both bond and equity markets, and for certain types of portfolios in March we added hedges in the form of option strategies and retained our positions in gold.

As higher oil prices are an exogenous shock, it will be a hard trade-off for the Fed between higher imported inflation through energy prices and lower economic growth and increased market volatility.

US Treasuries will certainly continue to be mostly impacted by strong inflation data, but they will also likely profit from their safe-haven characteristics in times of geopolitical tension. At actual yield levels, we could see some renewed interest from longer-term investors who need to rebuild bond portfolios.

In initial trading following the attack, markets took consolation from a lack of sustained damage to Israel and a call from Saudi Arabia for restraint, with S&P 500 futures up 0.4%, the EURO STOXX 50 up 0.47%, EUR/USD barely changed at 1.0659, and Brent crude up slightly (+0.5%).

  • Disclaimer
    Investing involves risk. The value of an investment and the income from it will fluctuate and investors may not get back the principal invested. Past performance is not indicative of future performance. This is a marketing communication. It is for informational purposes only. This document does not constitute investment advice or a recommendation to buy, sell or hold any security and shall not be deemed an offer to sell or a solicitation of an offer to buy any security.

    The views and opinions expressed herein, which are subject to change without notice, are those of the issuer or its affiliated companies at the time of publication. Certain data used are derived from various sources believed to be reliable, but the accuracy or completeness of the data is not guaranteed and no liability is assumed for any direct or consequential losses arising from their use. The duplication, publication, extraction or transmission of the contents, irrespective of the form, is not permitted.
    This material has not been reviewed by any regulatory authorities. In mainland China, it is for Qualified Domestic Institutional Investors scheme pursuant to applicable rules and regulations and is for information purpose only. This document does not constitute a public offer by virtue of Act Number 26.831 of the Argentine Republic and General Resolution No. 622/2013 of the NSC. This communication’s sole purpose is to inform and does not under any circumstance constitute promotion or publicity of Allianz Global Investors products and/or services in Colombia or to Colombian residents pursuant to part 4 of Decree 2555 of 2010. This communication does not in any way aim to directly or indirectly initiate the purchase of a product or the provision of a service offered by Allianz Global Investors. Via reception of this document, each resident in Colombia acknowledges and accepts to have contacted Allianz Global Investors via their own initiative and that the communication under no circumstances does not arise from any promotional or marketing activities carried out by Allianz Global Investors. Colombian residents accept that accessing any type of social network page of Allianz Global Investors is done under their own responsibility and initiative and are aware that they may access specific information on the products and services of Allianz Global Investors. This communication is strictly private and confidential and may not be reproduced, except for the case of explicit permission by Allianz Global Investors. This communication does not constitute a public offer of securities in Colombia pursuant to the public offer regulation set forth in Decree 2555 of 2010. This communication and the information provided herein should not be considered a solicitation or an offer by Allianz Global Investors or its affiliates to provide any financial products in Brazil, Panama, Peru, and Uruguay. In Australia, this material is presented by Allianz Global Investors Asia Pacific Limited (“AllianzGI AP”) and is intended for the use of investment consultants and other institutional /professional investors only, and is not directed to the public or individual retail investors. AllianzGI AP is not licensed to provide financial services to retail clients in Australia. AllianzGI AP is exempt from the requirement to hold an Australian Foreign Financial Service License under the Corporations Act 2001 (Cth) pursuant to ASIC Class Order (CO 03/1103) with respect to the provision of financial services to wholesale clients only. AllianzGI AP is licensed and regulated by Hong Kong Securities and Futures Commission under Hong Kong laws, which differ from Australian laws.

    This document is being distributed by the following Allianz Global Investors companies: Allianz Global Investors GmbH, an investment company in Germany, authorized by the German Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin); Allianz Global Investors (Schweiz) AG; Allianz Global Investors UK Limited, authorized and regulated by the Financial Conduct Authority; in HK, by Allianz Global Investors Asia Pacific Ltd., licensed by the Hong Kong Securities and Futures Commission; in Singapore, by Allianz Global Investors Singapore Ltd., regulated by the Monetary Authority of Singapore [Company Registration No. 199907169Z]; in Japan, by Allianz Global Investors Japan Co., Ltd., registered in Japan as a Financial Instruments Business Operator [Registered No. The Director of Kanto Local Finance Bureau (Financial Instruments Business Operator), No. 424], Member of Japan Investment Advisers Association, the Investment Trust Association, Japan and Type II Financial Instruments Firms Association; in Taiwan, by Allianz Global Investors Taiwan Ltd., licensed by Financial Supervisory Commission in Taiwan; and in Indonesia, by PT. Allianz Global Investors Asset Management Indonesia licensed by Indonesia Financial Services Authority (OJK).

    3511832

Recent insights

Embracing Disruption

Discover how an unconstrained thematic investing approach can help participating in the growth prospects resulting from an all-encompassing disruption.

Discover more

Secondary market transactions, or secondaries, involve trading existing investment fund shares. Secondaries have the potential to generate better risk-adjusted returns versus similar primary investments. This paper highlights the type of transactions, different players, and our key insights in the Private Debt Secondaries segment.

Discover more

Emerging markets fixed income has been buffeted by several forces in recent weeks. Middle East geopolitical tensions, higher US Treasury yields, US dollar strength and ongoing debt restructuring talks have made for a challenging backdrop.

Discover more

Allianz Global Investors

You are leaving this website and being re-directed to the below website. This does not imply any approval or endorsement of the information by Allianz Global Investors Asia Pacific Limited contained in the redirected website nor does Allianz Global Investors Asia Pacific Limited accept any responsibility or liability in connection with this hyperlink and the information contained herein. Please keep in mind that the redirected website may contain funds and strategies not authorized for offering to the public in your jurisdiction. Besides, please also take note on the redirected website’s terms and conditions, privacy and security policies, or other legal information. By clicking “Continue”, you confirm you acknowledge the details mentioned above and would like to continue accessing the redirected website. Please click “Stay here” if you have any concerns.