(Reuters) – Fears of a widening conflict in the Middle East are threatening more volatility for investors, adding to uncertainty ahead of corporate earnings season and crucial U.S. inflation data later in the week.
Israel’s troops were battling on Monday to clear out Hamas gunmen more than two days after they burst across the fence from Gaza on a deadly rampage, and the army said it would soon go on the offensive after the biggest mobilization in Israeli history.
Investors were on guard for the potential of the conflict spreading to embroil other countries, including Iran, and a continued spike in oil prices. U.S. stock futures were down 0.6% on Monday morning, while Brent crude was up around 3.4% to $87.47 per barrel. Prices for gold, a popular destination for investors during uncertain times, were up 0.8% at $1,847 per ounce.
“The coming days are likely to be driven by geopolitical risks, rather than fundamentals,” said Mohit Kumar, chief Europe economist at Jefferies in London. “For markets, the geopolitical risks add another uncertainty for investors when convictions are already low.”
The escalating conflict comes at a time of heightened uncertainty for markets, as investors grapple with a historic sell-off in U.S. Treasuries and volatility in stocks spurred in part by fiscal worries and concerns that the Federal Reserve will leave rates around current levels for longer than previously expected.
Soaring Treasury yields have pressured equities, with the S&P 500 off roughly 6% from its late July highs, though the index is up 12% for the year. Yields on the benchmark 10-year US Treasury – which move inversely to bond prices – stand at their highest levels in more than a decade and a half.
“The worst-case scenario from a geopolitical risk perspective would be a full-scale confrontation between Israel and Iran,” analysts at Fordham Global Insights said. “A return to the risk of direct military tensions – especially the risk of Israeli attacks on Iran’s nuclear facilities – would likely have systemic impact.”
A widening conflict could keep oil prices elevated, they said. That could complicate the picture for the Fed and other global policymakers, who have been seeking to tamp down inflation after consumer prices surged last year.
“Conflict is by nature inflationary, conflict in the Middle East, even more so,” Fordham’s analysts said.
U.S. earnings season, which kicks off on Friday, is expected to add another measure of uncertain. Meanwhile, investors are also bracing for inflation data slated for Thursday.
“I think this is just an extra source of concerns and the timing is not ideal, because the commodity market is already quite stretched, the bond market is quite stretched,” said Emmanuel Cau, Barclays head of European equity strategy.
For safe-haven government bond markets, worries about renewed tensions in the Middle East took the sting out of a brutal selloff that has seen 10-year borrowing costs from the United States to Germany to multi-year highs. Germany’s 10-year Bund yield was down 3 basis points at 2.87%, having pushed above 3% last week as investors continued to dump bonds on worries about rising bond supply and interest rates staying higher for longer. While U.S. markets were closed for a holiday on Monday, 10-year yields were trading at around 4.8% — not far off the psychologically key 5% marker.
Althea Spinozzi, senior fixed income strategist at Saxo Bank, said that while an escalation in tensions in Israel might boost the allure of U.S. Treasuries for haven-seeking investors, the risk of a rising commodity prices and looming Treasury auctions might limit any fall in yields.
“Within this environment, we remain defensive and wary of duration,” she said.
(Reporting by Naomi Rovnick, Dhara Ranasinghe and Marc Jones; Writing by Ira Iosebashvili)
