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- Soaring oil prices and market volatility are likely in the most extreme version of the Israel-Hamas conflict.
- In an "uncontained" scenario, oil prices could notch $150, EY's chief economist estimated.
- Meanwhile, the stock market's fear gauge could spike 18 points as volatility soars.
Oil prices could surge well into to the triple-digits and market volatility could skyrocket in the most severe scenario of an uncontained Israel-Hamas war, according to EY chief economist Greg Daco.
Daco proposed three possible ways the current conflict in the Middle-East could play out. The war thus far has sparked fears of a wider regional conflict, but markets so far have been relatively muted in their response.
The most severe outcome of the war is a "uncontained scenario," Daco said, where the war escalates and could ultimately see the involvement of the US or Iran, or both.
In that situation, oil prices could immediately spike by $50 a barrel, notching $150 a barrel in late 2023, Daco warned. Meanwhile, the VIX, a measure of market volatility known as the stock market's fear gauge, could see a severe spike, jumping at by at least 18 points.
Those effects will ease into next year, Daco said, forecasting that oil prices could fall back to just $10 above the baseline forecast in 2024, while market volatility eases to four basis-points above the baseline forecast.
Still, such a scenario, even short-lived, could come with severe consequences for the global economy, Daco warned. The impact could include a mild global recession, global real GDP growth falling 1.4% through the end of next year, and the world economy shedding around $2 trillion in value.
Financial conditions will also likely tighten, with stocks potentially falling as much as 20% while the US dollar jumps 10% in value. Global inflation could also rise, climbing 1.5 percentage points above EY's baseline 2024 forecast due to higher energy prices.
"This scenario would create a true headache for central bankers faced with an inflationary shock at a time when inflation remains well above official targets," Daco said.
"Still, the severe tightening of financial conditions and the global recessionary conditions would likely prompt major central banks, including the Fed, European Central Bank and Bank of England, to ease policy faster than in our baseline in early 2024, but not slash rates to zero as they would have done in prior crises. By the end of 2024, however, the 'higher-for-longer' mantra would once again prevail with central bankers deciding to ease policy less rapidly," he later added.
Markets are still largely expecting the Fed to keep interest rates high as central bankers remain hawkish on inflation. Investors are pricing in a 98% chance that rates will stay above 4% by the end of next year, according to the CME FedWatch tool.
Other outcomes of the Israel-Hamas war still involve a small spike in oil prices and market volatility over the near-term. In the best-case scenario, oil prices will only rise by $3 a barrel by the VIX rises one basis-point higher than originally forecasted over the next six months.
That's followed by the second-best relatively contained scenario, in which oil prices initially spike by $7 a barrel before easing to $3 higher than the baseline price forecast. Meanwhile, the VIX will spike five basis points in late 2023, before easing to just one basis-point higher than the baseline forecast by the end of next year.