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Iran's unprecedented military action against Israel raises the risk of a sharp escalation in the conflict, which heightens the risks that geopolitical tensions may have on global credit conditions and tests the limits of our base-case assumption underpinning sovereign ratings in the region.
What We're Watching
The recent missile and drone attack on Israel emanating from Iran represents an alarming expansion of the Israel-Hamas war.
In our second quarter assessment of top risks to global credit conditions, we determined that geopolitical tensions are the biggest risk to our macro-credit base case—and now with the region vulnerable to further conflict escalation, we believe that downside risks are worsening.
S&P Global Ratings will be closely watching four key developments over the coming weeks: Israel's reaction, the U.S.'s stance, Iran's risk appetite, and the evolution of trade choke points. At the same time, we are continuing to monitor key transmission channels (including energy prices, supply-chain disruptions, financial market volatility, and renewed inflationary pressures) that could affect credit conditions if the conflict widens significantly.
What We Think And Why
While this past weekend's events signal a significant increase in geopolitical risk, the central narrative of our base case remains broadly unchanged: We expect the Israel-Hamas war to continue through this year, with Gaza remaining at the epicenter and Iran and its proxies sustaining pressure on Israel.
From a macroeconomic perspective, the missile and drone attack does not yet change our global baseline assumptions for the world's major economies, which are experiencing resilient yet slower growth. Overall, the macroeconomic response to higher-for-longer interest rates is playing out largely as we've anticipated with slower activity and falling inflation pressures.
From a credit perspective, we maintain that geopolitical conditions and higher-for-longer rates are the two identified risks most likely to derail our base-case expectations for global credit conditions.
From a sovereign ratings perspective, a broader and protracted conflict could significantly heighten ratings risks for Middle Eastern sovereigns. We believe the evolution of the immediate crisis depends heavily on the nature and magnitude of Israel's response—and the risk of tactical miscalculations and other downside scenarios has increased. In our view, a sustained, unstable geopolitical backdrop characterized by sporadic escalation between warring parties is likely to remain a reality for the region.
What Could Change
A real concern is that a pathway to de-escalation in the medium- to longer-term is becoming even more fraught with obstacles, complicated by the recent attack. Political factions in Israel, Palestine, and Iran risk becoming more entrenched in their polarized views—creating potential implications for the viability of a two-state solution. This also heightens risks around the scope of an arms race in the region.
Further escalation and a broadening of the conflict could undermine current constructive credit market conditions—prompting a flight to safe haven assets; a reduction in risk appetite, confidence, and demand; and the potential for higher energy prices—that could result in central banks' delaying their expected monetary policy easing in advanced economies.
A protracted conflict could keep oil prices relatively high—hurting countries that are net energy importers. Gulf oil-producing countries could see their governments' difficulties in exporting their hydrocarbons offset benefits from higher oil prices if the conflict widens or lasts for a protracted period. This could increase their spending needs and hurt capital flows, financing costs, and economic growth.
While our ratings on Middle Eastern sovereigns already factor in a certain level of geopolitical volatility, we could take negative rating actions if the conflict evolves to the point that we see increasingly adverse macroeconomic implications for trade, financial flows, and tourism (in addition to the toll on affected populations). A full-scale conflict between states would be economically, socially, and politically destabilizing for the entire region and its financial markets.
Writers: Molly Mintz and Joe Maguire
This report does not constitute a rating action.
| Primary Credit Analysts: | Alexandre Birry, Paris + 44 20 7176 7108; alexandre.birry@spglobal.com |
| Jose M Perez-Gorozpe, Madrid +34 914233212; jose.perez-gorozpe@spglobal.com | |
| Dhruv Roy, Dubai + 971(0)56 413 3480; dhruv.roy@spglobal.com | |
| Secondary Contact: | Alexandra Dimitrijevic, London + 44 20 7176 3128; alexandra.dimitrijevic@spglobal.com |
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