Dire threats are ever present, even in periods remembered for tranquility, but rarely materialise full blown. Instead, events force leaders to take steps to prevent escalation.

— Ruchir Sharma, Financial Times, October 23, 2023

For all the headlines about the risk of wider escalation as the Israel–Hamas war unfolds, key leaders are indeed doing their utmost to prevent the spread of war. Investors believe they will be successful. Notably, although the cost of a barrel of Brent crude rose from$84.58 per barrel (pb) when Hamas first attacked Israel on October 7 to over $92 pb, it stands now at $87.45 pb. This is around 10 dollars below where it was a month or so ago.

It is, nevertheless, worth asking if investors have got it right or if are they placing too much faith in world leaders. In the past, in all of the 16 major Middle East-related geopolitical crises we have seen since 1945, markets quickly recovered after an initial sell-off. Given that fact by itself, they are likely to be right.

World leaders warn about escalation

As far as key leaders are concerned, pretty much without exception they are issuing dire warnings about escalation. However, these are, in my view, aimed primarily at energizing efforts to prevent this from happening.

Start with US President Joe Biden. America is for the first time trying to defuse an Israel-centred crisis without “hyperpower” leverage. Furthermore, as European haplessness and the low profile adopted by both Beijing and Moscow confirm, there is no other power willing and able to take up the task. (I don’t discount Beijing’s ability to bring some influence to bear in Tehran in response to the US request for help there, but it is telling, for one thing, that Washington felt it had to ask; i.e., the US did not expect China to act spontaneously.)

Given this new context, the October 18 Lexington column in The Economist argued that, although Biden has played a difficult hand deftly to date, the challenges he faces are only going to grow. If the conflict were to spread geographically, that growth would be exponential.

To try to head off this threat, we have not only seen the US move military forces into the region but also take a shot across the Israeli government’s bow, making it publicly known that hawkish members of the Israeli war cabinet have been pushing for a pre-emptive strike against Hezbollah.

I am not convinced that this would draw Iran directly into the conflict. Tehran has consistently shown no more than a willingness to supply its Arab proxies while remaining otherwise on the sidelines. But even a superficial review of the 2006 Israel-Hezbollah war confirms that major escalation on what is already an active front would still be very dangerous. Israel too has warned Hezbollah, and at least one Israeli minister has threatened Iran in the event of a major assault by its Lebanese ally.

Furthermore, although consideration of the domestic economy is low on the government’s agenda currently, there will be those who are mindful that, after the 2006 war, Israel suffered a deep and protracted recession. The country is better placed to weather a downturn now than it was then, but the sell-off in the currency since October 7 confirms that investors expect history to rhyme here too.

Coming back to the US, so far the war has helped Biden domestically. Again to quote Lexington, his “steady leadership” has provided a stark contrast to Donald Trump’s railing against Israeli Prime Minister Benjamin Netanyahu. However, the president’s balancing act would be complicated further if American lives were to be lost as a result of the war, including with progressives in his own party. Hence, in part at least, the US has made “surgical” strikes against Iran-backed militias in Syria.

Turning to Iran, its foreign minister too has been publicly warning of the risk of the conflict spreading. It would be wrong to dismiss this expression of concern simply as rhetoric. Hezbollah is Iran’s main deterrent against an Israeli attack on its nuclear program, and Tehran therefore has little interest in seeing it degraded by getting involved in a war in support of the Palestinians.

Even if clashes between Israel and Hezbollah remained at low intensity, there would remain a risk of the US abandoning its “blind eye” approach to Iranian sanctions busting. However, Tehran is sufficiently adept at sanctions evasion that it is unlikely that much, if any, of its oil exports would cease to flow.

Reactions in the Arab world

As for the Arab world at large, it is, as The Economist noted in another October 18 article, difficult to make generalizations. However, this same article was still correct to point out that, even though it does not equate to support for Hamas per se, “most Arabs still sympathise with the Palestinian cause. Their dispossession remains a totemic political issue across the Middle East, able to mobilise popular anger and protest like little else.”

In particular, this leaves the leaders of Arab states that have normalized diplomatic relations with Israel — or, like Saudi Arabia, have been moving towards doing so — with a tricky balancing act. As The Economist continues:

In off-the-record conversations … some Arab officials have spoken about Hamas and Gaza in the sort of language one would expect to hear from right-wing Israelis … But they dare not repeat such remarks in public … This is not an existential moment for Israel — but some Arab rulers fear it might be for them.

The probable course of the war is likely to boost these fears even without the conflict spreading more widely. Again, therefore, there is every reason to “take steps to prevent escalation.”

As for this “probable course,” currently, it appears that the US had some success in its efforts to delay a wholesale ground invasion of Gaza to allow more time for hostage negotiations, humanitarian aid and diplomatic efforts to prevent the conflict from spreading further. However, ground operations are now ramping up despite Israel having no clearly defined endgame or exit strategy. It is, in all probability, only as these intensify further that we shall get a definitive view of whether investors have called this crisis correctly or not.

[Anton Schauble edited this piece.]

[Arab Digest first published this piece.]

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.