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What the Israel-Palestine War Means for Forex Markets

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The recent escalation in the conflict between Israel and Palestinians started on Saturday, when markets were closed. That might have muted some of the impact on traders, as some of the initial fears of a broader conflict in the Middle East have not panned out. But, the rise of a geopolitical situation like this inevitably does affect the markets, and in particular exchange rates around the global.

First Reactions: Inflation?

Not surprising for a conflict in the Middle East, the price of crude shot up in the first hours of trading on Monday. Brent shot back up over $88/bbl, but faded some of those gains as the trading session wore on. OPEC+ agreed to keep their current production curbs in place, displacing some worries that the cartel would have cut even further. Israel isn’t itself a major oil producer, and if the conflict remains limited to around Gaza, the price of crude could normalize.

The issue that worries some analysts is the broader context. Before the start of the war, there were rumors that the US, Israel and Saudi Arabia were close to a diplomatic breakthrough. The rumored deal implied that Saudi Arabia would recognize Israel as a country, and increase crude production. With the Kingdom siding officially with the Palestinian cause at the moment, the conflict might mean that the deal has been scuttled.

It’s risk off, but not much

Rising oil prices would bring back the specter of inflation, particularly for the US and Europe. While US core inflation has continued to decline, headline inflation has been rising, and could eventually bleed through to the core rate and pressure the Fed to hike. A similar situation is seen in Europe, where the ECB has promised to not raise rates in order to not hurt the fledgling economy. But rising energy costs could pressure core inflation, right as higher costs hurt the economy, potentially weakening the Euro.

Gold saw some gains as well, even as the dollar got stronger. This was a reversal of the recent dynamics where higher yields were making gold less attractive as an investment. Though the move to safe havens might be short-lived, if the consequences of the war aren’t seen spreading. The fading in risk aversion could see the dollar and gold weakening, but also bring back a bump in yields as investors worry about how the US will pay for its growing debt.

Which dollar stands to benefit the most?

Canada’s main export is crude, which naturally makes its dollar one of the more likely candidates to benefit from higher crude prices. But Canada exports primarily to the US, which is less likely to be affected by the situation in the Middle East. Europe is more vulnerable, which relies heavily on crude imports from countries that could get involved in the conflict – particularly Egypt, which controls the straits of Suez, a large transport hub of crude going to Europe.

The US is also a net energy exporter, sending a substantial amount of crude and natural gas exports to Europe. An interruption in supply from the Middle East could more likely affect Europe, and increase demand for energy from the US, benefitting the US dollar, potentially even more than Canada, which doesn’t export significant amounts of crude to either Europe or China.

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