Israel/Hezbollah Scenarios

Israel’s attack on Hezbollah in the Lebanon and Houthi targets in Yemen has raised the geopolitical temperature.  We outline three main alternatives scenarios below. The probabilities we attached to these scenarios are approximate, as a lot of uncertainty exists about how the situation will develop. 

·       Israel/Hezbollah intermittent attacks/counterattacks (40%).  The current Israel offensive against Hezbollah will continue to try to degrade Hezbollah military capabilities.  Eventually Hezbollah will regroup and undertake missile counterattacks against Israel, which will led to more airstrikes against Hezbollah.  This could become intermittent through the next 12 months. This could also involve some Israel ground incursions into southern Lebanon. This will keep tension high in the region, but Iran may not get drawn in directly.  Iran is suffering economically and does not have the fiscal resources to fight a direct war with Israel, while the domestic unrest (civil rights/cost of living) has been against the regime over the last 18 months more than Israel.  Iran will also want to see the outcome of the U.S. presidential election, given Donald Trump hostility to Iran – an Iran attack on Israel could then draw in the U.S., if Donald Trump is president.   

·       Significant ground invasion Southern Lebanon (45%).  The prime military and political aim for Israel appears to be allowing people to return to northern Israel, which would require a buffer zone in southern Lebanon – the Litani river 30km above the Israel border is seen to be the natural break.  This is high probability scenario, given that Hezbollah will likely counterattack after the death of their leader.  This is also high risk, as the 2006 war with Hezbollah saw initial Israel success grind to a halt and then a UN ceasefire agreeing no Hezbollah forces below the Litani river.   

·       Prolonged ground war Israel/Hezbollah and others (15%).  A 3 scenario is that Israel could decide to try to destroy Hezbollah, with Iran’s current domestic weaknesses and Hezbollah currently disoriented.  Public opinion in Israel has backed a harder line over the last year, but a full scale war in Lebanon would be more difficult than 1982 when Israel got to the suburbs of Beirut as it attempted to destroy the PLO.  This third scenario could also draw in other countries, as Israel could feel it has an opportunity to attack Iran nuclear facilities or Iran could feel that it has to become involved; Russia indirectly to distract from Ukraine or the U.S. could be drawn in depending on how the situation escalates. At face value Trump would be more pro-Israel than Kamala Harris, but Trump is also reluctant to get the U.S. involved in prolonged military conflicts.       

These scenarios have probabilities that are broadly estimated, as events could escalate or de-escalate.  Hezbollah does not want a war with Israel, but events are moving in that direction.  Iran is torn between supporting its proxies and domestic weaknesses that could make a war with Israel destabilizing and potentially prompt regime change in Iran.  This means the situation needs to be watched closely to see how it evolves.

So far global markets have not reacted much, as the focus has been on interest rate cuts.  Additionally, oil prices have been subdued by weak China oil demand and OPEC+ considering reversing production cuts (here).  This limits the economic fallout globally. A tactical ground invasion of southern Lebanon by Israel could trigger a temporary market reaction, but the 3 option and other countries being drawn in would be the scenario that catches market attention and a risk off reaction.