Iran-Israel war: How escalating Middle East conflicts could affect Indian stock market, commodity prices

Tensions in the Middle East have intensified with the escalating conflict between Iran and Israel, raising concerns about a possible full-scale regional crisis. If the situation worsens, it could significantly affect global crude oil prices, as Iran is a major oil producer.

A sharp rise in oil prices would likely hinder expectations of central banks cutting interest rates, as higher inflation could make economic recovery more challenging. The increase in crude prices could also weigh heavily on investor sentiment in emerging markets like India, which relies on imports for 80% of its oil needs.

With Indian stocks already trading at premium valuations, a prolonged conflict could prompt global investors to shift their focus away from India, currently one of the world’s top-performing stock markets. In such a scenario, investors might move their capital from riskier assets like Indian equities into safer havens such as bonds or gold.

Geopolitical tensions in the Middle East have sharply escalated as Iran recently launched around 180 ballistic missiles at Israel, specifically targeting military bases and security installations. This was in direct retaliation for the killings of leaders from Hamas, Hezbollah, and Iran's military.

Iran has issued warnings to Israel, threatening further missile strikes if Israel responds. In turn, Israel is preparing a major counterattack, with potential targets including Iran's oil production facilities and other key strategic sites.

The response is expected to involve airstrikes, covert operations, and possibly targeted assassinations. The U.S. has affirmed its support for Israel’s right to defend itself, with President Joe Biden warning of "severe consequences" for Iran's actions.

Impact on Indian stock market

India, currently recognized as one of the best-performing stock markets globally and the leading emerging market, may encounter significant challenges if the conflict escalates further. Historically, war brings unpredictable consequences, making it difficult to assess outcomes. In such uncertain times, investors typically seek to minimize volatility in their portfolios by shifting their focus to safer assets.

So far this year, foreign portfolio investment (FPI) inflows into Indian equities have exceeded ₹1 lakh crore, indicating global investors' confidence in the economy, even though stock valuations remain relatively high. However, experts warn that this trend could reverse as tensions in the region intensify, adversely affecting global trade dynamics and crude oil prices.

A sustained conflict may prompt foreign investors to reconsider their strategies, potentially leading to a withdrawal of capital from the Indian market as they seek refuge in more stable, less volatile investment options.

Nevertheless, in most of the instances in recent times, whenever foreign investment flows move away from the Indian markets, they are consistently offset by domestic inflows, minimizing any potential declines. This continuous support from domestic investors helps maintain market stability, ensuring that decreases caused by reduced foreign interest are largely mitigated.

Impact on gold prices

Gold prices have reached multiple peaks this year, outperforming all other asset classes. This surge can be attributed to various factors, including central banks shifting their dependence away from the dollar, institutional investors diversifying their portfolios, and a strong demand for jewelry among retail investors. As a result, gold has soared to record levels.

Despite rising tensions in the Middle East, gold prices have shown limited reaction as the recent strong U.S. labor data has tempered gold’s upward momentum by diminishing expectations for the Federal Reserve to adopt a more lenient monetary policy.

According to the ADP National Employment Report released on Wednesday, private U.S. payrolls increased by a larger-than-expected 143,000 jobs last month. This data has heightened expectations for a robust reading of the upcoming monthly non-farm payroll figures.

Currently, traders estimate a 34.6% chance of a 50 basis-point U.S. rate cut on November 7, following the Fed's recent easing cycle, which began with a significant reduction last month. In addition to the tensions in the Middle East, traders are closely monitoring the size of the next Fed rate cut, as it could heavily influence gold prices.

Interest rate implications

Major equity markets reacted positively to the U.S. Federal Reserve's decision to cut interest rates in September, which was soon followed by highly anticipated policy measures from China. These actions boosted investor confidence, prompting a surge in riskier assets such as equities.

However, the escalating tensions in the Middle East are beginning to cast a shadow over global investor sentiment and could influence the direction of major central banks' future policies.

Over the past few months, the global monetary easing cycle has begun, with central banks around the world cutting interest rates after a prolonged period of maintaining decade-high levels to combat inflation. These rate cuts were seen as necessary to stimulate economic growth, but the ongoing conflict between Iran and Israel poses a significant threat to this recovery.

There is growing concern that the conflict could escalate further, potentially drawing in other major nations, which would severely disrupt global trade and supply chains.

The combination of geopolitical risk and economic uncertainty may force central banks to rethink their strategies, potentially delaying further rate cuts or even causing a shift back to tightening monetary policies in response to rising inflationary pressures caused by surging oil prices and trade disruptions.

Disclaimer: The views and recommendations above are those of individual analysts, experts, and brokerage firms, not Mint. We advise investors to consult certified experts before making any investment decisions.