• Iran launches strikes against Israel, but markets don’t panic 

• Traders seem hopeful this won’t escalate into full-blown war

• How Israel responds will be crucial for risky assets and oil prices

Political theater? 

Tensions in the Middle East reached boiling point over the weekend after Iran launched drone and missile strikes against Israel, in retaliation to an Israeli attack on an Iranian diplomatic consulate in Syria earlier this month.

With the help of US forces, Israeli defense systems managed to intercept almost all of the more than 300 drones and missiles launched by Iran. While a few ballistic missiles did get through and struck an Israeli air force base, fortunately there were no casualties and little material damage.

Indeed, the Iranian attack was so telegraphed that it appears to have been symbolic in nature. The drones would take several hours to reach Israel and once they were flying, Tehran claims to have warned the United States of the ongoing attack, to avoid escalation. And after the attack ended, Iranian authorities even tweeted that the ‘matter is concluded’.

Therefore, this strike seems mostly like political theater. Iran launched a half-hearted attack that would almost surely be intercepted, to send a message that it could really strike Israel if it wanted to, while avoiding a true escalation that would lead to war. This way, the theocratic regime in Tehran can also ‘save face’ with domestic audiences.

Traders seem hopeful of de-escalation

Now the question is whether and how Israel will retaliate. The fear is that this could devolve into a tit-for-tat cycle of escalation that ultimately goes too far and drags the entire region into conflict.

On the bright side, President Biden made it clear the United States won’t join any Israeli retaliation against Iran. Instead, he urged Tel Aviv to show restraint. With Iran also signaling it wants to avoid a war, investors seem to have concluded that any retaliation will be limited and cooler heads will prevail, even if the situation is extremely dangerous. 

Reflecting this optimism, oil prices were little changed on Monday, which suggests market participants are not terribly concerned about a regional conflict that impacts energy production.

That said, stock markets fell and gold prices edged higher, which suggests that there is an element of concern among investors.

What’s next for markets? 

Moving forward, Israel has vowed to retaliate, so the scope and scale of that response will decide how global markets react. Some media reports suggest Israel is exploring attacks on Iranian facilities that would avoid causing casualties.

But when nations keep exchanging blows this way, there is always a risk of an accidental escalation, even if the two sides are simply trying to ‘send a message’.

A direct strike against Iranian territory could fuel more concerns about a tit-for-tat escalation, which could keep risky assets such as stocks under pressure, while helping to boost oil and gold prices.

On the flipside, if Israel takes a more measured approach and pushes for diplomatic or economic sanctions, traders might become more confident that the aftershocks will be contained. This could spark a recovery in riskier trades, at the expense of oil and gold prices, as geopolitical risk is priced out.

Ultimately, most signs point to de-escalation as neither side wants an all-out war, nor does the United States. That said, this is an unstable situation and there’s a risk it can spiral out of control even by accident, so geopolitical fears might linger for some time.