The U.S.-Iran conflict escalated again on Thursday before abruptly swinging back toward diplomacy, producing another day of extreme volatility in both energy and financial markets. The escalation began after two days of renewed exchanges between Washington and Tehran following the downing of a U.S. Army helicopter near Hormuz earlier this week. On Tuesday and Wednesday, U.S. forces retaliated against Iranian targets, while Iran responded in kind. Early on Thursday, Trump threatened to seize Kharg Island, which handles Iran’s crude exports, warning of attacks overnight (in the manner of Venezuela). Those remarks sent oil prices higher until later on Thursday, when Trump reversed course, saying the strikes had been cancelled and a deal was “close”, sending crude in the other direction as the market appeared to simply dismiss Iran’s denial of any agreement in the works. Oil trades on every Trump headline these days. Oil has effectively become a referendum on Trump’s latest social media post.
In Israel …
Israel is reorganizing its statehood around permanent militarization as a long-term economic strategy. Since October 2023, defense spending has more than doubled, the government has accumulated roughly $138 billion in war-related costs, public debt has climbed from about 60% of GDP to nearly 70%, and Netanyahu is openly arguing that Israel must become a “super-Sparta” capable of sustaining prolonged regional conflict while reducing its dependence on U.S. military…
The U.S.-Iran conflict escalated again on Thursday before abruptly swinging back toward diplomacy, producing another day of extreme volatility in both energy and financial markets. The escalation began after two days of renewed exchanges between Washington and Tehran following the downing of a U.S. Army helicopter near Hormuz earlier this week. On Tuesday and Wednesday, U.S. forces retaliated against Iranian targets, while Iran responded in kind. Early on Thursday, Trump threatened to seize Kharg Island, which handles Iran’s crude exports, warning of attacks overnight (in the manner of Venezuela). Those remarks sent oil prices higher until later on Thursday, when Trump reversed course, saying the strikes had been cancelled and a deal was “close”, sending crude in the other direction as the market appeared to simply dismiss Iran’s denial of any agreement in the works. Oil trades on every Trump headline these days. Oil has effectively become a referendum on Trump’s latest social media post.
In Israel …
Israel is reorganizing its statehood around permanent militarization as a long-term economic strategy. Since October 2023, defense spending has more than doubled, the government has accumulated roughly $138 billion in war-related costs, public debt has climbed from about 60% of GDP to nearly 70%, and Netanyahu is openly arguing that Israel must become a “super-Sparta” capable of sustaining prolonged regional conflict while reducing its dependence on U.S. military support.
For decades, Israel’s economy has been built around a rather narrow, yet highly productive, base, heavily weighted towards tech, software, cybersecurity, semiconductors, defense exports, pharmaceuticals, and professional services. A small percentage of the workforce employed in high-value sectors effectively subsidizes a much larger welfare state, extensive public services, and one of the most sophisticated militaries in the world.
The model works. Indeed, Israel manages to attract capital and retain highly educated workers, and it is deeply integrated into Western financial and technology networks. But permanent military mobilization is still taking its toll, pulling Reservists out of the workforce, diverting government spending to the military, and making the investment climate uncertain.
The challenge for Israel is that many of the sectors carrying the economy are also the most sensitive to uncertainty. The tech industry accounts for roughly a fifth of GDP, more than half of exports, and a sizable share of tax revenues. Because these companies can relocate investment, talent, and intellectual property more easily than traditional industries, investors may be more tolerant when it comes to a short war or even a series of military campaigns, as we have seen. However, a state explicitly organizing itself around permanent confrontation means that investors have to ask: Can Israel’s most productive economic sectors continue operating under the assumption that conflict is forever?
Right now, investors are betting, very clearly, that Israel will come out on top, even though a surprising number of financial analysts note the disconnect between economic performance and military reality. The shekel is strong, and equity markets remain elevated, with risk premiums having fallen pretty dramatically. Tax revenues are stronger than expected. This is because investors are pricing in a future in which Iran, Hezbollah, and Hamas emerged severely weakened against an Israel that ends up with a much stronger strategic position than it had before October 2023.
In other words, investors are not pricing in war. They are pricing in an end state. How long will that hold?
The militarization raises some infrastructure questions, as well, that investors should be considering. Israel is increasingly treating economic infrastructure as part of its national security architecture. The proposed sale of shipping giant ZIM to Germany’s Hapag-Lloyd is triggering major opposition from multiple Israeli ministries–all of them arguing that transferring effective control of the company could undermine Tel Aviv’s ability to secure critical imports during a conflict.
The transaction would leave behind a much smaller regional carrier while placing much of the existing operation under foreign ownership. And it’s not just about commercial shipping. ZIM handles a significant share of Israel’s containerized imports and food shipments, making it one of the country’s most strategically important economic assets.
And in Lebanon …
Israel is using the ceasefire to lock in territorial control. This week, Israeli strikes hit Tyre and other parts of southern Lebanon, with Iran threatening retaliation. The Israeli military ordered residents of Tyre to leave, and then launched airstrikes, killing eight people and wounding dozens more across southern Lebanon. Hezbollah, which rejected last week’s ceasefire deal brokered without it, fired back at Israeli positions. Israel isn’t exactly behaving like southern Lebanon is a temporary battlefield. The Israelis are fortifying their positions here, across southern Lebanon and Syria. Roads are reportedly being widened, watchtowers erected, etc.
Saudi Arabia’s decision to lift its almost-five-year ban on Lebanese imports adds another layer to this. Right now, Washington is trying to push Beirut into a settlement that would weaken Hezbollah and restore state control, ostensibly. Riyadh is trying to give Beirut a bit of a boost. (Before the 2021 ban, Lebanese exports to Saudi Arabia were worth about $100 million annually). It’s economic relief and a political reward of sorts. Riyadh sees a chance to pull Lebanon further away from Hezbollah’s grip while it’s still under Israeli military pressure. Israel is trying to force the issue from the south. Washington is trying to formalize it diplomatically.
But, there are plenty of Lebanese political voices that can see through this ruse as external forces bargain away its future. Essentially, Beirut is being asked to negotiate under conditions where Israel continues to occupy territory, conduct air strikes, and expand its military footprint.