By Schroders
General Sir Nick Carter, a strategic adviser, discusses what is behind the escalation of risks:
Following the events of October last year, the situation in the Middle East has become increasingly volatile. In April, Israeli forces attacked the Iranian consulate in Damascus, killing most of the Quds Force leadership.
The Quds Force is part of the Iranian National Revolutionary Guards Corps, which deals with Iran’s overseas activities and its relationships with its proxy forces in Syria, Lebanon and Iraq.
In recent months, Israel has been testing Iran’s red lines, with attacks against Iran’s proxies. However, the attack in Damascus would have certainly exceeded Iran’s red lines as it would view the consulate as sovereign territory.
How important is Iran in the conflict?
The demise of the State of Israel has been a declared intention of the Iranian government since the 1979 revolution. And therefore, what Iran has established since 1979 are proxy militias in the countries that ring Israel – Lebanon, Syria, Iraq and Yemen.
However, due to the parlous state of Iran’s economy, brought on by the level of sanctions imposed on it, I don’t think that there is any great appetite within Iran (or among the country’s population) for a regional conflagration with Israel at the moment. But we should be in no doubt about the threat posed by Iran.
A “multi-aligned” world
Along with North Korea, Iran is in an alliance with Russia, with Iranian drones being manufactured under Iranian auspices inside Russia and being employed on the battlefield in Ukraine. The three countries could become a malevolent anti-Western alliance.
Iran will continue to be disruptive because it doesn't want stability in the region. It wants to ensure that it remains a regional power with regional capability and influence. If Israel signs agreements with other Arab states, it could lose this position of power.
It’s been notable that China has kept its head below the parapet when it comes to what has been going on. It also appears to have come to some sort of accommodation with Yemen’s Houthi rebels because Chinese shipping seems to be able to pass through the Red Sea. China is not so openly hostile because it recognises the need to have a relationship with the West.
China is playing a circumspect role in all of this and doesn't particularly want to get embroiled in the conflict. However, it can probably see an advantage in the US being put in an awkward position and that is exactly how Russia would see it as well.
Indeed, Russia has reached out to Hamas, and we've seen the Hamas political leadership visiting Moscow. We’ve also seen Hamas's political leadership talking to President Recep Erdogan in Turkey.
Matthew Michael, an investment director EMD and Commodities at Schroders, on the possible market implications:
Market volatility could spike in the near-term, but thus far, the global market impact has been mostly limited. Purely from a market perspective, the most immediate potential impact is higher oil and gold prices due to the risk of oil supply disruption from the Middle East and investors looking for havens, such as owning gold.
Oil prices have climbed this year, but the rise has more to do with US production not increasing as expected, Opec rolling over production cuts to H2 and Russian refining capacity being disrupted by Ukraine’s drone attacks. There seems to be broad consensus that de-escalation will be the most likely outcome, despite the attacks from Iran being much larger than expected. The risk premium in the oil market, specifically related to the tension in the Middle East, is therefore limited for the time being. The current price is well below the peaks of the 1970s and the previous bull market both in nominal and inflation adjusted terms.
Overall, geopolitical risk premiums in commodities remain low despite recent events and the upcoming US election.
Duncan Lamont, the head of strategic research at Schroders, considers past precedents
Stock markets often fall in the near-term when geopolitical risk spikes, as markets re-assess risk. Past performance is not a guide to the future, and every situation is different but, historically, they have started to recover strongly within a matter of months. Staying the course, rather than making a knee-jerk reaction, has worked out for the best.
The chart below shows the total return of the S&P 500 index in the year following other events that caused heightened geopolitical risk.
It’s becoming clear that the Western narrative has not resonated in what people now call the Global South, and there are a number of countries now that, due to their individual economic and political clout, are able to be multi-aligned.
The world is now a much more complex place. It’s a messy, multipolar world in which there is a risk that the alliances can come together and make mischief in a way that causes global challenges, not just in certain regions.
No appetite for war in the region
The reality is that if politics becomes bellicose, then there’s a real danger of miscalculation. And if you get an unwarranted escalation, then the danger is that it could lead to somewhere that we don’t want to go. Regardless of people not wanting war at the outset, it doesn’t mean we won’t end up with a war.
The Schroders Economics Team considers the possible economic impact of a wider conflict
The Schroders Economics Group produces a set of risk scenarios designed to examine the impact of potential events and risks around some of the underlying assumptions made in our baseline economic forecast.
One such scenario is “Middle East war” which assumes that the localised fighting in Israel spreads across the region, and also drags Western nations into the conflict. In this scenario, the war is assumed to not only disrupt key shipping channels but also the supply of oil, causing wholesale prices to spoke towards $150 (R1 800) per barrel.
In this event, the macroeconomic impact would likely be stagflationary for the global economy. Higher inflation caused by the shock to commodity prices could meet a severe shock to corporate confidence, which would likely reduce capital expenditure at a time of great uncertainty. The situation would force central banks to push back the start of rates easing. Delayed easing cycles may then weigh on growth in 2025.
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