Opinion: Even as Israel-Hamas war escalates, the global economy will be fine

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John Rapley is a political economist at the University of Cambridge and the managing director of Seaford Macro.

Concern is rising that the violence in Israel and Gaza will widen. After a second U.S. carrier group was dispatched to the eastern Mediterranean, alongside ships from some NATO allies, some speculated that Washington knew something it wasn’t publicly revealing. One prominent commentator went so far as to warn we might be headed into World War Three, a warning that seemed prescient when Israel began evacuating the zone along its border with Lebanon in apparent preparation for the opening of a second front.

That second front would be with Hezbollah, the Iranian-backed Lebanese militia. A recent article in The Wall Street Journal claimed that Iran had organized the attack by Hamas in Israel, and Israel’s recent bombardment of airports in Syria would suggest it is trying to stop Iran from arming both Hezbollah and its client Hamas. Tehran has responded with rhetorical force, its Foreign Minister this week declaring that it was ready to join the fight.

If that were to happen, the war would immediately assume regional proportions, threatening the supply of oil and driving prices sky-high. Even more worrying to some analysts is that Iran’s close relationship with Russia, and in turn Russia’s close relationship with China – as evidenced by Vladimir Putin’s visit to Beijing this week – could make the war go global.

Yet for all this, there are still few signs of anxiety in global markets. The price of oil has budged only slightly higher over the past week and remains below the highs it reached late last month. Meanwhile, the telltale signs that global investors are getting nervous, such as rallies in the prices of gold and U.S. Treasuries, have yet to materialize. On the contrary, market movements suggest investors think the good times will roll, with stock prices and bond yields still on an upward path.

Is this a case of investors seeing something the journalists and analysts reporting on the war aren’t? Investors are hardly infallible seers, of course, but since they have skin in the game, they at least try to discern which way the geopolitical winds are blowing. And for the moment, at least, their calm suggests they consider the risks of the war spreading to be low.

That expectation still appears reasonable. The Journal article looked dubious from the start, and since its release both the Americans and the Israelis have dismissed suggestions Iran was behind the tragic events that started this conflict – which is itself revealing, because nobody would like to blame the Iranians more than Israeli Prime Minister Benjamin Netanyahu. But joining the war would entail huge costs for Iran; Israeli and U.S. retaliation would be devastating, and if there is one thing to which Iran’s ruling elite is committed, it is its own survival.

Nevertheless, that’s not to say Tehran couldn’t get drawn in, even reluctantly. Israel has committed to the extermination of Hamas. It’s not even clear that can be done militarily, but in any case it would require the Israel Defense Forces to launch a full-scale occupation of Gaza. Such an eventuality would not only trigger a humanitarian catastrophe far worse than what we’re already seeing, but raise the risk of an immediate escalation: it’s hard to picture Iran standing by as its ally Hamas goes to the wall.

That’s probably why forestalling such an invasion now appears to be the primary goal of the Biden administration, the President’s visit to the region showing how vital a task that has become. It appears that Washington’s full-throated support for Israel in public conceals some fierce private pressure to scale back the military plans. And in apparent response to U.S. pressure, the Israeli government has at least postponed the launch of its ground invasion of Gaza.

For as long as that tense equilibrium holds, we’ll probably continue to see calm in world markets. In effect, investors are sizing up the situation and judging the scenario to be very high-risk but low-probability. Instead, they’re keeping their eyes on conditions in the world economy – and in their own economies. And what those indicators suggest is more of the same: continued if slow growth, steady but stubborn inflation, healthy job markets and rising interest rates. For the time being, therefore, the biggest risk to asset prices appears not to be a world war but rising interest rates.

That will probably continue for as long as the violence remains contained within Gaza and Israel. The canary in a coal mine for any eventual widening of the war will probably be found on Israel’s border with Lebanon, because Hezbollah would be the weak point in the Iranian chain most likely to break and get drawn into the war. For as long as the tensions there don’t explode, markets will continue turning a blind eye to the unimaginably awful situation that Hamas’s horrors have set loose.