Markets monitor potential risks of increased tension between Netanyahu and Iran

• On Tuesday night, Iran launched an unprecedented missile barrage into Tel Aviv, prompting Israel's government to vow a severe response, leaving the Middle East on edge.
• The likelihood of an Israeli retaliation has caused markets to prepare for potential consequences. Defense stocks are surging, and oil observers perceive a heightened risk to oil supplies.
• One of OPEC's largest producers, Iran, could become a target for Israel, putting as much as 4% of global oil supply at risk.

The Israeli government has pledged a stern reaction to Iran's unprecedented missile attack on Tel Aviv, increasing tensions in the Middle East as concerns grow about a potential all-out war between the two age-old adversaries.

On Tuesday evening, Israel was attacked by approximately 180 ballistic missiles launched from Iran, which Tehran claimed was a retaliation for the Israeli assassination of Hezbollah leader Hassan Nasrallah a week prior.

Israeli authorities reported that no casualties resulted from the offensive, and most of the strikes were intercepted. However, the event signaled a turning point in a series of escalatory tit-for-tat moves, as Tehran remained determined to re-establish deterrence and demonstrate to Israel that it could and would attack at its discretion.

The possibility of an Israeli retaliation against Iran has caused markets to prepare for what may come next. Defense stocks are surging, and oil prices, which have been dormant for a while, may also rise as a result of this perceived threat to crude supplies.

One of OPEC's largest crude producers, Iran, could become a target for Israel, putting as much as 4% of global oil supply at risk.

In the previous session, oil prices increased by more than 5% following the missile strike, before settling for a 2.5% rise. At 10:30 a.m. in London, the December delivery contract of global benchmark Brent was trading at $75.37 per barrel, while front-month November U.S. West Texas Intermediate futures were up 2.68% to $71.70 per barrel.

While the focus may seem to be on Israel, the real focus should be on Iran and the possibility of attacks on regional infrastructure, which could lead to a more dangerous path for stock markets and risk assets, as stated by Frederique Carrier, head of investment strategy for the British Isles and Asia at RBC Wealth Management, during an interview with CNBC's Capital Connection on Wednesday.

"Since the 1940s, oil crises and prolonged increases in oil prices have had a lasting impact on stock markets."

She stated that so far, there is no evidence of that.

Oil infrastructure 'tempting targets for Israel'

An adjunct professor of intelligence at Sciences Po in Paris, Lewis Sage-Passant, characterized energy markets as unstable due to investors' concerns about Israel's future actions.

""Iran's energy sector is concerned about the escalation of a tit-for-tat of strikes against regional infrastructure, as much of the world's oil infrastructure is under the flight paths of missiles that could be used to target Iran's 'chokepoint' export terminals, such as Khark island," Sage-Passant said."

According to Roger Zakheim, a former U.S. deputy assistant defense secretary and director of the Ronald Reagan Institute in Washington, the U.S.'s efforts to de-escalate and prevent a region-wide conflict have clearly failed following the Tuesday attack, and the U.S. National Security Advisor Jake Sullivan warned of severe consequences for Iran, saying that the U.S. would staunchly support Israel.

The Israeli response to Iran's attack may have a significant impact on oil, energy markets, aviation, and the defense sector. Companies that manufacture and produce missile defense and ammunition systems are likely to be affected by the events unfolding in the Middle East.

On Wednesday morning, European defense stocks also increased due to rising conflict risks, with Saab and BAE Systems adding 2.2%, and Thales and Rheinmetall both rising more than 1.3%.

Zakheim stated that Israelis will respond not only in kind but will take necessary actions to restore deterrence.

Deterrence, or full-blown war?

Would a strong Israeli response restore deterrence or lead to further escalation from Iran and a full-blown war? Iran's Foreign Minister Abbas Araghchi stated in a post-missile salvos statement: "Our action is finished unless the Israeli regime invites further retaliation. If that happens, our response will be stronger and more powerful."

Critical infrastructure on both the Iranian and Israeli sides could be targeted, according to Sara Vakhshouri, founder and president at SVB Energy, who spoke on CNBC's Capital Connection on Wednesday.

""The sheer size of Iran makes it impossible to secure all of its infrastructure," she emphasized."

Some market watchers are warning oil could hit $100 per barrel.

Vakhshouri questioned the accuracy of the forecast, stating that geopolitical events typically only affect oil prices temporarily. The degree and duration of any market impact would depend on the location and quantity of oil affected by the destruction.

"While it is certain that prices will increase, the market is also facing significant uncertainty on both sides, whether it's due to demand or geopolitical factors."

The global demand outlook is a key factor influencing long-term oil prices. Brent crude reached a 33-month low in mid-September and remained near $70 per barrel until Iran's missile attack on Israel, which was driven by slowing global demand and an oversupply of oil, particularly from non-OPEC+ producers.

"Vakhshouri stated, "The current moment is quite intriguing as the market's prices remain resilient due to the fear of low demand and geopolitical factors. Any side could potentially push the market, and we have observed how prices fluctuate based on market sentiments in the past few days.""