Escalating Israel-Iran conflict to keep markets on boil in near term

Mint

17 hours ago

Global markets, including India's benchmark indices, have been rattled by escalating geopolitical tensions as Israel launched airstrikes early Friday targeting Iran's nuclear and military infrastructure.
The strikes reportedly came in response to Iran being on the brink of developing nuclear weapons, amplifying the instability across West Asia and fuelling fears about oil prices remaining stubbornly high.
The Israel-Iran conflict has sent Brent crude prices soaring above $75 a barrel, stoking fears of inflationary pressure driving up input costs and threatening the profitability of Indian companies. Brent crude surpassed $78 per barrel on Friday before retreating from its peak. Still, prices have surged 8% over the past two sessions.
Market participants are also worried that the intensifying conflict could force the Reserve Bank of India to hit the brakes on more rate cuts or abandon them altogether.
RBI has gradually cut its policy repo rate from 6.25% at the beginning of this year to 5.5% recently, its lowest since August 2022, as it seeks to spur economic growth after years of focusing on keeping inflation under check.
Also read | The Reserve Bank's leap of faith: A big rate cut is very hard to justify
According to Madhavi Arora, chief economist at Emkay Global Financial Services, 'every $10 per barrel increase in oil leads to an annualised gain of 35 basis points in CPI (consumer price index-based) inflation".
Amid rising uncertainty, investors are making a beeline for traditional safe havens like gold, with the yellow metal up 4% in the past two sessions, crossing the crucial Rs1 lakh-mark on Friday.
The 10-year-bond yield remained largely flat on Friday, inching up 1 basis point to 6.36%. However, the rupee weakened in early trade, with experts pointing to interventions by RBI to stem losses. Rupee closed at 86.09 per dollar, down 49 paise.
This, in turn, has sparked a broadbased sell-off in Indian equities.
Indian markets currently offer limited margin for error with modest earnings growth and pockets of sharply elevated valuations, said Hari Shyamsunder, vice president and senior institutional portfolio manager–emerging markets equity–India, Franklin Templeton.
The rising geopolitical risks could push up commodity prices, stoke inflation, and 'trigger a broader risk-off sentiment", he added. 'While not yet a structural threat, such developments could temporarily cap the recent rally in Indian equities."
Next rate cut in October—'if at all"
On Friday, both the Nifty 50 and the S&P BSE Sensex closed 0.7% lower, ending at 24,718.60 and 81,118.60 points, respectively. Since Thursday, both benchmarks have declined by around 2%. The Nifty Midcap 100 and Nifty Smallcap 250 declined by 0.4% each.
Sectors that contributed the most to Friday's losses were financial services, oil and gas, and fast moving consumer goods.
India VIX, also known as fear gauge, jumped 8% on Friday, indicating increased volatility.
Geopolitical risks mostly lead to sharp, short-term falls followed by recoveries for markets, said market expert Ajay Bagga, adding that oil supplies link is a big risk to Indian markets apart from a global risk-off that could see selling by foreign portfolio investors (FPIs).
Bagga said he hoped the impact of the Israel-Iran conflict on the markets will be short-lived but cautioned that any existential threat to the Iranian regime could lead to attacks on US and Gulf Cooperation Council assets in the region, which might increase volatility in markets.
That said, RBI is on pause mode given the shift to neutral from an accommodative stance. Bagga believes the next rate cut by the central bank will now be in October, 'if at all".
Also read | India to benefit from foreign inflows, stock-specific approach better, says Yogesh Patil of LIC AMC
The 10-year-bond yield remained largely flat on Friday, inching up 2 basis points (bps) to 6.36% at 3:28 pm. However, the rupee weakened in early trade, with experts pointing to interventions by RBI.
Sriram Iyer, senior research analyst at Reliance Securities, said that after the rupee tumbled to an eight-week low in Friday morning trade amid rising geopolitical tensions, rising crude oil and trade uncertainty, dollar sales from RBI capped further losses.
Although RBI does not target any level of the currency, it intervenes to curb excessive volatility.
The rupee has depreciated by 1.6% since early May amid rising crude oil prices and volatile FPI flows, per Care Ratings. Since January, the rupee has remained broadly flat while most other currencies have gained against the US dollar.
Also read | What drives the new corporate love for bond market
Global market chaos
All things considered, the escalating conflict in West Asia amid mounting expectations of a robust Iranian retaliation has weighed heavily on US futures and Asian and European markets, dragging them lower.
US Dow futures are down over 500 points while France's CAC 40 was down 1.1% and Germany's DAX dropped 1.4%. Japan's Nikkei, China's Shanghai Composite, South Korea's Kospi and Taiwan Weighted—all fell by around 1% each. Hong Kong's Hang Seng was down 0.6% while Singaporean Strait Times slipped 0.3% on Friday.
Shortly after the strikes began on Friday, US Secretary of State Marco Rubio issued a statement describing Israel's move as a 'unilateral action' and cautioned Iran against retaliating against the US.
JP Morgan said in report dated 12 June that market attention is focused on the risk that an escalation in the conflict could lead to the closure of the Strait of Hormuz—a crucial sea passage in the Persian Gulf—or trigger broader retaliation from major oil-producing countries in West Asia, which together account for a third of global oil output.
Under such a severe outcome, oil prices could 'surge to the $120-130/bbl range", it added.
Also read | Global equity markets not pricing in a severe downturn just yet, says Nomura's Karkhanis
Ashish Gupta, chief investment officer at Axis AMC, said that such geopolitical uncertainty is generally 'an antithesis to buoyant markets", and cautioned that risks to global trade are likely to weigh on corporate earnings.
'Investors in this environment, where there is economic and geopolitical uncertainty, would ask for higher risk premium," he added.
According to Gupta, key triggers in the near term could be further geopolitical developments and how the global tariff landscape unfolds. On the tariff front, he said extreme outcomes are unlikely for now, suggesting that much of the downside risk may already have been priced in.