Attack on Israel Raises Middle East Tensions
Bottom Line: Retaliation by Israel is highly likely but it is uncertain what scale Israel will attack Gaza and Iran forces in Syria or whether Hezbollah will be drawn in. If the escalation is moderate, then the lasting impact on global market may not be major in the autumn. In contrast major escalation to a multi-dimensional war would likely cause more persistent global financial market tensions on concerns that the U.S. military could be drawn in in support of Israel.
Hamas attack on Israel has caused renewed Middle East tension, but how will the situation develop in the coming weeks?
Israel immediate aim is to reestablishes control of its own territory as Israeli forces continue to fight against Hamas gunmen to recapture its towns, which may take longer than Israeli forces originally expected. Israel will likely then retaliate further in Gaza against Hamas after the brutal attack that has killed hundreds of civilians. The next question is whether this will involve a ground assault on Gaza, as Israel will likely want to try to destroy Hamas’s capability to undertake further attacks. Such a ground assault by Israel could occur in the coming weeks, which will likely escalate tensions in the Middle East still further. The impact on people and civilian society will remain very high on both sides. Egypt will watch this closely, but is unlikely to be involved if Israel focus is on military targets in Gaza. However, Israel response elsewhere will likely be more important ultimately for the Middle East.
A WSJ report has suggested that Iran helped Hamas over a number of weeks prior to the attack, which risks a retaliation by Israel against Iran. One of the reasons behind the attack is likely to have been a desire to undermine U.S. sponsored negotiations to normalize Saudi Arabia and Israel relations. It is possible that Israel could decide to attack military targets in Iran, which would spiral the conflict to a new level and cause major geopolitical tensions in the oil market and worldwide. Instead, it is more likely that Israel could attack Iran military advisors in Syria. Since 2011, Israel has undertaken hundreds of such attacks, but the risk is that retaliation for Hamas attack on Iran could be on a more substantive scale. This then risks retaliation from Iran on Israel, while also inflaming regional tensions and also raise tensions with Russia and Turkiye if any Israel attack in Syria is too broad, particularly considering both Russia and Turkiye recently announced de-escalation of the tension in the region and support for a free Palestine state
Hezbollah in Lebanon is also an issue, especially with Iran support for Hezbollah. So far only skirmishes have been reported, but Hezbollah has large number of rockets and the capability to attack Israel and widen the conflict. Such a development would be viewed badly, as it would produce counterattacks from Israel and also raise tensions between Israel and Iran. This could occur before an attack by Israel on Iran military advisors in Syria.
Overall, the situation is fluid and will likely escalate in the coming weeks. This will keep tensions in global financial markets, which can keep oil prices elevated and produce some short-covering in U.S. Treasuries on flight to quality flows. However, it is uncertain what scale Israel will attack Gaza and Iran or whether Hezbollah will be drawn in. If the escalation is moderate, then the lasting impact on global market may not be major in the autumn. In contrast major escalation to a multi-dimensional war would likely cause more persistent global financial market tensions on concerns that the U.S. military could be drawn in in support of Israel.