‍

Reports of the conflict between Israel and Hamas have dominated global headlines this week. The pain and suffering of innocent lives caught in the crossfire are palpable through every story and image in our news feeds. Our thoughts are with all the families who have lost loved ones and we are praying for swift peace to come over the region.

During conflicts like these, the interconnectedness of our world becomes evident. Global markets, reflective of the complex web of international relationships, are delicately trying to gauge the ripple effects of this unrest on nations and their respective currencies. For those seasoned in observing market dynamics, there's an understanding that situations evolve swiftly, and initial reactions may not always capture the complete picture as events progress. Nonetheless, we have put together an initial look at how the response of the FX markets may take shape in the coming weeks or months.

Initial Market Reaction to Outbreak of Conflict

• The US dollar (DXY) moved higher in Monday’s Asian markets in reaction to the news. The brief rally stalled at the London open, and the dollar edged lower for the rest of the global trading day. By the end of the New York session, the dollar was fractionally lower than Friday’s close.
  ‍
• Not surprisingly, the Israeli shekel dropped sharply. This move prompted the Central Bank of Israel to intervene, reportedly selling up to $30 billion to stem the slide in the shekel.
  ‍
• Overall, FX volatility was relatively low, considering the potential global effects of a worsening conflict. At its best level during the Asian trading session, the dollar was up less than 0.5%. Reactions in other currencies were likewise muted. Most major currencies finished the day with moderate changes from Friday’s closing prices.
  ‍
• The biggest market reaction was in crude oil. Prices moved sharply higher and oil closed up by 4% (from under $82/barrel to $85/barrel) on Monday. That move, while notable, should be taken in the context of an oil market that had dropped by over 12% in the preceding six trading days. Oil was arguably oversold and ripe for a short-covering rally. 

What to watch for in the financial market’s reactions in the coming weeks:

Increased FX market volatility: Any signs that the conflict may spread to include Israel’s Middle Eastern neighbors could cause a spike in FX volatility. Markets will be focused on any news that indicates a lessening or heightening of tensions in the area.

A move to “safe-haven” currencies: It is common for currencies that are viewed as “above the fray” to benefit in times of international chaos. Usually, the dollar is viewed as the safest currency in times of stress, though flows into the Swiss franc or Japanese yen could occur. In this case, the yen may not be a safe-haven beneficiary if oil prices remain elevated since Japan imports all of its oil.

The currencies of oil-exporting countries could move higher: If crude continues to rally on the belief that other Middle Eastern countries will become involved in the conflict, this could result in the strengthening of the Russian ruble and the Mexican peso.

Intervention by central banks: The Bank of Israel has already shown it is willing to defend the shekel, though it is believed that it has already spent much of its available dollar reserves on the intervention of October 9. The initial FX market reaction took the shekel to a 7-year low (USDILS 3.98) against the dollar. Any further weakening of the shekel would point to a retest of the all-time low of 4.10.

It is still too early to predict what will happen over the next few days and weeks. As mentioned above, the current effects of the war on FX markets are relatively subdued. However, this could change quickly as events unfold. 

Companies should do a thorough analysis of their FX market volatility risk factors, and take appropriate mitigating measures, including hedging any obvious currency risk. Over the long term, if the conflict escalates or has long-lasting consequences, it can impact trade relationships, economic stability, and investor confidence in the region. These factors can have a more prolonged impact on currency exchange rates.

Pangea will continue to provide market updates alongside developments in the region.