Bond investors stuck in uncertain middle on threat of wider Middle East conflict

Investing.com -- Bond investors are now stuck in an uncertain middle as the threat of the Iran-Israel conflict causing a wider war is set to linger, keeping oil prices higher, and the Federal Reserve in a higher for longer interest rate stance to guard against inflation.

This uncertain middle isn't a good place for bonds, Macquarie said in a Monday note, describing the current geopolitical Middle East landscape as "not grave enough to cause a flight-to-safety to bonds, nor disinflationary enough to want to own bonds."

Israel is reportedly weighing up an imminent response to an attack from Iran over the weekend, NBC reported Monday, citing an unnamed Israeli official. The news come just days after Iran launched a retaliatory attack on Israel after accusing the latter of striking its consulate building in Syria. 

If the current conflict deescalates enough resulting in bona fide peace, without a war of attrition and without the threat of a wider regional war in the mid-east, albeit highly unlikely, then this would be disinflationary because history shows that wars are inflation, it added. 

"Wars demand more resources to be directed toward defense and war-making, Macquarie says, causing supply chains to shift to less optimal configurations and consumers and business to hoard. 

The more likely scenario - neither one that calls for wider regional conflict nor a bona-fide peace - is a 'war of attrition,' Macquarie estimates, saying that in this scenario Israel, by avoiding a wider war, would be a able to maintain an anti-Iran regional coalition. 

In the war of attrition, which has been ongoing between Iran and Israel, "the threat of super-power involvement stays low," curbing the prospect of a wave of bids into safe haven bonds, but the potential for supply disruptions and higher oil prices will keep the Fed guarded against inflation, keeping U.S. rates higher for longer, likely denting bond prices. 

If, however, the axis of war were to tilt in favor of a much wider war - with super-power involvement - Macquarie said it would ditch its bearish bet on bonds, but reiterated that's not its base case as it believes that "an intensified 'war of attrition' is likelier."

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