The geopolitical risks of direct military conflict between Israel and Iran are huge, but so are the economic risks if the conflict escalates in the coming days and weeks.
If the conflict widens, Israel — one of America’s closest allies — could be facing a multifront conflict, as it is already engaged in a war in the Gaza Strip and guarding against potential attacks from Hezbollah, an Iranian proxy based in Lebanon. Depending on the breadth of the conflict, the economic effects could extend to the U.S. and across the world.
The backdrop
The outbreak of war between Israel and Hamas following the latter’s terrorist attack in southern Israel and killing of civilians on Oct. 7 led to military action in multiple areas. Earlier this year, Israel attacked an Iranian embassy complex in Damascus, Syria, killing some top Iranian military officials, including the commander of the Quds Force, a branch of the Islamic Revolutionary Guard Corps responsible for special operations in other countries.
Iran vowed retaliation, and Israel began planning its defense. In the early hours of Saturday morning, Iran launched hundreds of drones and ballistic missiles directly from its borders into Israel. The vast majority were successfully intercepted by Israel, the U.S., the United Kingdom, France, and Jordan, although some hit Israeli soil.
Now, Israel has said it will respond, although the exact response is unclear and the scale would matter significantly in whether the conflict will expand. Iran has said it would hit back more forcefully than before should there be a counterattack.
Energy prices
Perhaps the biggest near-term economic threat of a direct conflict between Israel and Iran would be global energy prices surging.
The Middle East region is one of the world’s largest oil exporting areas and a conflict could crimp supply and cause oil prices to jump. Notably, oil prices were down on Monday as markets waited to see what the response will be from Israel. Brent, the global benchmark, was trading down about 1%, while West Texas Intermediate futures, the U.S. benchmark, were down by about the same amount.
A large share of the world’s oil passes through the Strait of Hormuz, a strategic choke point between the Persian Gulf and the Gulf of Oman. If Iran chose to cause disturbances through the passage, it could cause oil prices to spike. In the lead-up to Iran’s Saturday strike against Israel, a Portuguese-flagged container ship, the MSC Aries, was seized by Tehran in the strait.
In October, after Hamas attacked Israel, Bloomberg Economics made projections about what a direct war between Israel and Iran could look like globally. Researchers estimated that in such a worst-case scenario, oil prices could soar to $150 a barrel. On Monday afternoon, Brent was hovering around $90 a barrel.
Higher oil prices stemming from the conflict will have a direct effect on consumers stateside and on the U.S. Federal Reserve’s fight to bring down inflation. Higher oil and gas prices have the knock-on effect of raising prices in other industries — for instance, by raising costs for truckers who are shipping goods across the country. The prices of those goods might end up being increased to make up for the higher shipping costs.
Global markets
Beyond just energy prices, a war between Israel and Iran would roil global markets.
The specter of a war between Israel and Iran would cause stocks to fall. On Monday, as investors awaited Israel’s response, the S&P 500 fell more than 1%, while the tech-heavy Nasdaq lost about 1.5% in total value.
Generalized anxiety on Wall Street is captured by the Chicago Board Options Exchange Volatility Index, better known as VIX but also as the “fear index.” Notably, the VIX was up about 9% on Monday.
Brian Marks, executive director of the University of New Haven’s Entrepreneurship and Innovation Program, said on Monday that an expansion of the conflict would increase uncertainty in the global economy, noting it adds to the continuing spillover from the war in Ukraine.
“As a result, more uncertainty could very well tamp down expectations in the stock market, meaning growth in the market may slow in response or decline,” he told the Washington Examiner.
A broader conflict could also fray supply chains, according to Marks. Frayed supply chains during the pandemic caused serious headaches and added to inflationary pressures from the supply side. Any problems with shipping and trade would be unwelcome for the U.S., which is working to slow price growth.
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Recession
If a conflict were to spiral out of control, it could usher in a global recession. While economists were anticipating a recession during the worst of the country’s inflationary bout and as the Fed raised interest rates, those fears had largely subsided.
But if energy prices were to suddenly skyrocket and markets plunge, it could be bad news for the Fed, which has kept interest rates high in order to stifle inflation. The central bank appears poised to keep rates high into the second half of the year. If the economy were to face a major exogenous shock and unemployment started to rise, though, that calculus could change.