Israel at War Transmits Market Risk Across Middle East

The fallout from the deadly Hamas attack ripped through Israeli assets this week, catapulting the region into what could be a new era of risk and casting a pall over markets from Saudi Arabia to Egypt.

(Bloomberg) — The fallout from the deadly Hamas attack ripped through Israeli assets this week, catapulting the region into what could be a new era of risk and casting a pall over markets from Saudi Arabia to Egypt.

As traders brace for more turmoil in Israel, they are also ramping up protection against the threat that the nation’s war against Hamas could lead to a wider conflict in the Middle East. Long seen as less prone to volatility, Israeli markets were hardly immune this time.

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The cost to insure Israeli bonds against potential default has spiked by 66 basis points since Saturday’s assault by Hamas, the biggest surge ever in a week. A jump in the shekel’s one-month implied volatility has surpassed every other currency in the world since Monday.

The superlatives are also piling up across the region. 

Credit-default swaps on Saudi Arabia and Qatar are headed for their biggest weekly gains since 2020. And as a hedge against rising geopolitical risk, 12-month forward contracts on Saudi Arabia’s riyal — which is pegged to the dollar — are on course for their biggest weekly gain since December 2022.

“Clearly a geopolitical risk premium is being built back into the region,” said Abdul Kadir Hussain, head of fixed-income asset management at Arqaam Capital. “The situation is fluid, difficult to predict.”

Investors are weighing the danger that the conflict could draw in other countries or militant groups. 

Lebanon’s Hezbollah, one of the Middle East’s most powerful militias, has exchanged fire with Israeli troops on the border over the past few days. 

Iran, which supplies arms and money to Hamas, warned that Tehran-backed militants could open a new front in Israel’s war against Hamas if the blockade of Gaza continued. Hamas is designated a terrorist organization by the US and the European Union.

A sharper escalation that engulfs the region “is not priced in today,” said Morgan Stanley strategists including Simon Waever. “Yet, such a scenario is also several steps away.”

Policy Response

Soon after the shock assault, policymakers in Israel rushed in with emergency measures that included up to $30 billion of currency interventions to limit the shekel’s volatility. 

The crisis also focused attention on Egypt, which shares the border with Gaza and is one of the region’s most indebted countries. Struggling to unlock financing from its existing $3 billion rescue package from the International Monetary Fund, it’s now in talks for an increase in assistance, according to people familiar with the discussions.

While Israel’s dollar debt has been among the biggest losers across emerging markets, bonds issued by Lebanon, Jordan and Egypt have also been among the hardest hit this week, according to Bloomberg indexes. 

The war will leave Egypt’s bonds, already under pressure after last week’s downgrade by Moody’s Investors Service, more vulnerable given its dependence on tourism and fuel imports, according to Goldman Sachs Group Inc. Jordan is also highly reliant on tourism, strategists at the US bank said. 

‘High Correlation’

“There is a relatively high correlation between heightened geopolitical risk in Israel and in the Middle East,” Goldman strategists including Kamakshya Trivedi and Caesar Maasry said in a report.

Israel’s benchmark stock index has slumped 6.4% this week, the biggest loser worldwide. The shekel has weakened more than 3% against the dollar even as interventions by Bank of Israel rein in volatility. 

Moody’s, which is scheduled to review Israel’s rating later Friday, said earlier this week that the nation’s sovereign credit profile could be tested by a protracted period of war, even though it’s has held up in the face of terrorist attacks and military action in the past.

As the Israeli military urged an evacuation of the northern part of Gaza with a ground operation expected soon, losses are set to deepen if the conflict develops into a broader war.

“Markets are reflecting an assumption that the Israel-Gaza war remains contained,” said Hasnain Malik, a Dubai-based strategist at Tellimer. “The prospects of a direct war with Iran, which would prompt a complete reset of risk assessment, seems very unlikely — but one with Hezbollah in Lebanon, which would be much more incremental, is possible.”

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