By Naomi Rovnick, Nell Mackenzie, Marc Jones
LONDON (Reuters) -An escalation of the Israel-Gaza war into a broader conflict could deliver another shock to world growth and halt disinflationary forces in their tracks.
Market reaction has been modest so far, but that could change.
"Whether this conflict remains limited to a confrontation between Hamas and Israel or escalates into a broader regional conflict involving Iran's proxy armed groups, notably Hezbollah, will have significant implications," said Hamza Meddeb, director of the political economy programme at the Malcolm H. Kerr Carnegie Middle East Center in Beirut.
"Such an escalation could lead to increased oil prices, concerns about oil supply, and the potential for a global economic downturn."
Here are some scenarios in focus.
1/ IRAN, THEN OIL
The potential for Iran to become more involved and for a U.S. response that sees a scaling up of sanctions on Iranian oil is in the spotlight.
"A crackdown on Iranian oil exports could immediately remove somewhere from 1-2 mbd (million barrels per day) off (the) market almost instantly," said hedge fund Cayler Capital's founder and CIO Brent Belote.
In the unlikely event the United States sends troops into the Middle East, Belote expected a $20 jump in oil prices, "if not more".
Oil jumped over 2% to over $92 on Wednesday and gained 7.5% last week.
From October 1973 to March 1974, as the Yom Kippur war prompted an oil embargo on Israel's supporters by Arab nations, oil surged over 300%.
"Israel has better relations with other Arab countries compared to then," JP Morgan private bank strategist Madison Faller said in a note, "and global oil supply is not as concentrated."
Nadia Martin Wiggen, director at commodity investor Svelland Capital, added a regional conflict would disrupt oil tanker routes in the Mediterranean, Black Sea and around Turkey.
2/ INFLATION SPIKE?
An inflation surge has eased and global rate hikes are nearing an end.
A spike in oil, which briefly hit $139 after Russia's invasion of Ukraine last year, could halt inflation's downward move. Gas prices surged 45% last week, another worrying sign.
"If Iran gets involved that means higher commodity prices, higher external shocks, and this is a trigger for a less disinflationary outlook," said Alessia Berardi, head of emerging markets macro and strategy research at Amundi, stressing this was not her base case.
Long-term market gauges of U.S. and euro area inflation expectations suggest inflation staying above 2% targets.
Further pain for bond investors could be likely. The S&P U.S. aggregate bond index, a marker of how Treasuries and corporate debt are performing, is 14% below January 2021 peaks.
3/ STRONG DOLLAR?
Demand for safe-havens has boosted the dollar, pushing it towards 150 yen, and the Swiss franc, which on Friday posted its best day against the euro since January.
The dollar may not be a one-way bet if high oil and inflation trigger a U.S. recession, said Amundi's Berardi.
Trevor Greetham, head of multi-asset at Royal London, said any "global risk-off move" could also strengthen the yen as "Japanese investors pull their money home."
4/ SUBMERGING MARKETS
Israel's currency, bonds and stocks have been hit by the troubles, as have those in Egypt, Jordan and Iraq and to a lesser degree Saudi Arabia, Qatar and Bahrain.
After a difficult couple of years, the Israel-Gaza war "is just one more thing dampening emerging market sentiment," said Barings' Head of EM Corporate Debt Omotunde Lawal.
She is cautiously optimistic that most other emerging markets are largely shrugging off tensions for now. Morgan Stanley does not expect contagion either.
But Aegon (NYSE:AEG) Asset Management's Jeff Grills warned a regional escalation could "easily" see oil jump 20%, hurting dozens of already-impoverished oil importing countries.
5/ TECH JITTERS
What's good for oil stocks can be bad for big tech.
MSCI's gauge of global tech stocks moved inversely to oil and gas shares in 2022 as war in Ukraine pushed up oil, feeding inflation fears that were captured by higher bond yields.
That pattern could form again, Royal London's Greetham said, if U.S. rates rise again to contain the inflationary effects of the latest conflict.
The potential disruption to infrastructure is also a risk.
"Egypt is one location where multiple intercontinental cables cross land in a digital Suez Canal," Deutsche Bank said. "At least 17% of global internet traffic crosses this route."
Airline stocks meanwhile could suffer while defence stocks outperform. Since the Oct. 7 Hamas attacks in Israel, MSCI's airline stock index is down about 5%. Aerospace and defence shares are almost 6% higher.