Economic Outlook on the Israeli-Palestinian Conflict

Escalating geopolitical tensions and the risk of aggravation in the context of the Israeli-Palestinian conflict are adding new challenges to a fragmented world. The international economic and financial system can only emerge from this situation weaker, as inflation persists and growth remains weak.

The Hamas attack on Israel on October 7 is a reminder of the 1970s and the sharp rise in oil prices that followed. But, as always, history only repeats itself. The current period is singular and deserves to be analyzed in the long term. It marks the end of an economic cycle that began in the aftermath of the World War II and has seen several crises, including the two oil shocks of 1973 and 1979, as well as the crises of 2000 and 2008. Several historical factors point to this: the multiplicity of issues at stake (particularly demographic, economic and social), the level of indebtedness of the major powers (as high, in terms of wealth produced, as in the 1930s) and the rise in military budgets worldwide. In short, it's not an extension of the past, but a leap into the future, because tomorrow's world is being decided by today's conflicts. And this is why democracy is weakening: the future is more uncertain than ever.

Yet, without this perspective, there is every reason to believe that the Hamas-led attack on Israel could lead to a repetition of history: A war hits the region, the price of crude oil rises and, although there are no signs of available supply, certain countries, including Iran, will abuse their position as oil producers (as the Gulf states did in 1973) in diplomatic relations. Saudi Arabia and Russia have been playing this role for several months, and intend to continue it by reducing their production by the end of the year. In a globalized economy still largely dependent on fossil fuels, the risk of pressure on prices is high. In emerging economies in particular, where energy often accounts for a significant share of inflation, but also in the United States, where price rises have been accelerating again for several months now. The Biden administration is preparing for this conflict to continue, and plans to purchase six million barrels of oil in December and January as part of its emergency stock replenishment plan. Henceforth, inflation trends in many countries are now partly conditioned by the duration and scale of the conflict in the region.

New risks are emerging. In this age of hyper-digitization, one of the other threatening issues is digital. Since October 7, groups of pro-Russian and pro-Iranian hackers (whose cybersecurity services have become highly competent) have been attacking Israeli government sites and national press magazines, flooding their websites with information of all kinds. Israel, known as a "cyberpower", has not ceased to retaliate (alongside the Americans and Indians), to the point of completely blocking communications in the Gaza Strip. These attacks are localized, but are multiplying everywhere else, particularly in the banking sector, where massive embezzlement is taking place. Among various forecasts, the British insurance market Lloyd's of London estimates that a large-scale cyber-attack on international payment systems could cost the institutions concerned $16 trillion in the most extreme case, not to mention the loss of confidence such an event would engender on the interbank market.

Already, uncertainty surrounding geopolitical tensions, combined with an unintelligible Fed statement, are influencing international financial markets. For several weeks now, major liquidations have been taking place on the bond market. And bonds are at the center of market concerns. The benchmark US 10-year yield is now trading at a significant 5%, its highest level since 2007. While the US 2-year rate is over 5%, a sign that the short term is more dangerous than the long term, according to the market. These increases are having an impact on all market rates, particularly real estate, where rates are rising steadily. While real property prices fell by 8.4% in the first quarter of 2023 in advanced economies, the IMF estimates in its latest report on financial stability that a 10% fall in property prices would affect asset wealth by 30% of GDP. This is because the global real estate market represents around three times GDP, and the bulk of bank loans. 

By extension, the main indices have been affected and are continuing their correction. The S&P 500 has posted three consecutive months of losses, its worst period since the health crisis in March 2020. The index is 10% below its peak, just as corporate results are starting to be released. For its part, the Nasdaq is losing ground under the influence of the main technology stocks, which, let's not forget, largely determine market trends. Despite a spectacular start to the year, driven by ongoing government support and the appeal of artificial intelligence, the seven leading US tech companies are slipping back. Their outlook is not very reassuring in a more than uncertain environment. Nearly $900 billion in market capitalization has been wiped out over the past two weeks, with Alphabet - Google's parent company - recording its third-worst session ever on Wednesday October 18, with a 9.5% fall and losses of $180 billion.

These are risk-averse times. Any financial fragility threatens to turn into banking contagion. Stocks that have historically resisted periods of instability are no longer resilient. They have been overtaken by the international context and, above all, by the Fed's restrictive policy. At least in the short term. 

Investors are watching the geopolitical context and economic data very closely, hoping that the latter will be as unfavorable as possible so that the Fed does not raise interest rates. In particular, the announcement of a 4.9% rise in US GDP in the third quarter was seen as a bad sign, prompting the markets to react. A "new reality": finance, which is supposed to serve the real economy, reacts negatively to a positive economy. And this, despite the fact that the real economy is dependent on the markets, thanks to the public authorities' ongoing support for systemic financial institutions, whatever the cost. The lender-of-last-resort mechanism introduced by the US Federal Reserve after the SVB bankruptcy is an illustrative example. By accepting liquidity at face value (whatever its current value), the US central bank becomes dependent on the latent losses incurred by banks since the rise in interest rates.

Against this backdrop of geopolitical and financial uncertainty, gold is fulfilling its role as a safe-haven asset, despite rising real interest rates. Since the Hamas attack, its price has risen by around 10%, a sign of buyers' interest in an asset that, unlike bonds, offers no dividend. The close relationship between real yields and gold is therefore showing its limits. And in the current period of market volatility, demand for gold is increasing all the more. This demand is being driven by governments, particularly China and Russia, but also by investors of all kinds who fear a widening conflict and market volatility. The uniqueness of the yellow metal attracts. Never affected by a zone concerned (unlike government bonds), gold is also not dependent on political decisions or those emanating from any authority (as can be the case with most financial assets).