Iran Responds

It has been two weeks since Israel’s airstrike against Iran’s embassy in Syria that killed several senior members of the country’s Revolutionary Guard. During this time, the world has been waiting and worrying about Iran's response. A limited response would mean little risk of escalation but make Iran look weak. A forceful response would make Iran look forceful to its citizens and allies but would risk a significant escalation of tensions in the region. As the markets pondered what Iran would do, energy prices rose as a result of heightened uncertainty and increased geopolitical risk.

Yesterday, we finally saw Iran’s reply to Israel's air strikes. Iran launched a drone and missile attack directly into Israel. This is the first time Iran has directly attacked Israel from its territory. According to reports, the attack included approximately 300 drones and cruise and ballistic missiles, which targeted Israeli military installations. Israel, with the help of the United States and other allies, intercepted 99 percent of the incoming barrage. It reported no material damage or loss of life as a result of the attack.

Iran went to great lengths to telegraph its response. In effect, it informed the world of the attack’s general timing and scope. Moreover, Iran's mission to the United Nations stated that its response it deems the matter of Israel’s attack on its Syrian embassy concluded. There can be little doubt Iran felt compelled to respond to Israel's attack to show its citizens and allies its resolve but also wanted to carefully calibrate its response so as not to escalate the situation. Iran presumably does not wish to escalate the situation not only because of the uncertainty it would create but also because it does not wish to divert attention away from the current crisis in Gaza. The Gaza crisis is impacting Israel’s relationship with the United States and other developed nations, as well as having an impact on its internal politics. Some argue that this is precisely why Prime Minister Netanyahu struck Iran’s embassy in Syria – to divert attention away from Israel’s activities in Gaza and the West Bank and also apply pressure on President Biden and the United States.

The question now is how will Israel respond to these drone and missile attacks.

On the one hand, Israel has proven its defence capabilities are more than capable of protecting the country and its citizens from Iran and other neighbours. In short, it has been proven that its deterrence capabilities work. On the other hand, Israel has never been directly attacked by Iran, and there can be little doubt hardliners in Netanyahu’s coalition will want to respond to Iran's direct attack on Israel.

Based on the Biden administration's response, the United States appears to be counselling Israel to exercise prudence and restraint. Iran's reaction, while symbolic, caused no real damage to Israel or its citizenry. As such, the US view is that Israel should look at this as a “win” and move forward. Undoubtedly, the United States is looking to avoid a tit-for-tat escalation of this situation that causes a regional crisis and potentially draws it into the conflict. The United States is also keenly aware that Iran’s major allies, Russia and China, will be carefully watching the situation and assessing its consequences from a broader view.

We would expect global energy prices to rise sharply on Sunday evening and early Monday to reflect this new reality in the region. While Iran did telegraph its intentions, its direct attack on Israel did change the status quo ante. However, the durability of this rise in the markets will depend heavily on Israel's next move period. One would expect Israel to heed its most crucial ally’s advice. However, recently, this has not been the case with regard to the Gazan crisis.

We would expect increased volatility during the week as the markets attempt to gain a clearer view of the situation. The developed markets, which are already suffering from a resurgence in inflation, can little afford further increases in energy prices. Nonetheless, with geopolitical tensions on the rise, this is precisely what they are getting.

This will be an interesting week on many fronts, and we, like many others, will be watching news developments and energy prices very closely.