Israel/Hezbollah--Ground Invasion in Lebanon?//European Populism//US Polls and VP Debate

One day last week, I awoke early to a text message from a journalist in the Middle East requesting my comments on news reports out of Washington DC about a proposed 21-day cease-fire between Israel and Hamas. Although I was not aware of the reports, my instinct was to question the logic that Israel would accept such an agreement, given that it has avoided succumbing to US and European pressure so far.

All along, as faithful FGF readers will know, we have cautioned that Israeli PM Netanyahu is likely playing for time and would resist agreeing to a ceasefire or significant compromise until after US elections, partly in the hopes of the return of a more sympathetic former President Trump to the White House, partly due to his own instinct for political survival—but mainly because the current strategic calculus favours Israel going as far as it can to change the facts on the ground and enhance its negotiating position while the pre-US election window remains open.  This is what the logic of PQ—Political Quotient—tells us, even when “insiders” may say otherwise, as did a famous general I was on stage with the day before the latest attack.

Instead of a ceasefire, a highly sophisticated “decapitation” operation of the leadership of Hezbollah ensued, first via exploding pagers, then walkie-talkies, and then the detonation of more than a dozen 2,000-pound bombs in a residential neighbourhood in Beirut, killing the commander of Hezbollah, Hassan Nasrallah, an assassination target for Israel’s Mossad for the past 18 years, along with scores of civilians. Security experts around the world have marveled, half-shocked, at the sophistication of the Israeli intelligence operation that has pulled off this highly-damaging and immensely daring attack. But not only does the attack against Hezbollah and virtually all its senior leadership go some distance to restoring the stature of Israel’s humiliated security services just short of a year after the October 7th Hamas attacks, it accomplishes several other important objectives.

First, these attacks could not have been successful without infiltration and cooperation deep inside Lebanon and the ranks of Hezbollah itself. That leads to the second key implication: the degree to which Hezbollah is loathed by much of the population of Lebanon, which it effectively holds hostage, by the Syrians who sought to challenge Bashar al-Assad, and by the leadership of the GCC nations, which deeply resent Hezbollah’s actions as a regional chaos agent and proxy for their adversary, Iran.

The third key implication is that this attack has further exposed the vulnerability of the regime in Tehran, having also suffered the indignity of brazen assassinations within its own borders. News reports have stated that Iran’s Supreme Leader, Ayatollah Khamenei, was immediately moved to a “safe” location. But the regime in Iran will undoubtedly be wondering whether anywhere is safe after the events of recent months.

Navigator Watchlist: The Top Geopolitical Risks to Markets and the Business Environment

What are the implications for regional stability and for financial markets of the recent Middle Eastern upheaval? It has been my longstanding view that the conflict would escalate, and indeed, it continues to escalate meaningfully. In the September Navigator Watchlist we flagged the risk of regional conflict escalation as highly likely in the pre-US elections period, for the reasons outlined above. But between the incremental nature of the attacks, the absence of significant retaliation from Tehran (so far) and most importantly for markets, the lack of “barrels at risk” in oil terms, there is very little price action to show for the extensive upheaval in a strategically-significant part of the world.

Nevertheless, in my view it is not correct to dismiss these developments as “noise” while we wait for a signal, but rather a breakdown in the usual transmission mechanism for geopolitical risk to asset prices. The 2006 Israel-Hezbollah confrontation did impact oil prices. This time around, oil prices have actually dropped, but the impact on supply chains is more palpable.

What could disrupt the current uneasy state of play would be an all-out Israeli ground invasion into Lebanon, which was reported to be in progress earlier on Monday, then downgraded to limited incursions. The “big one” in regional terms would be an attack on Iran’s nuclear facilities, which has been repeatedly war gamed as having devastating impact, or a sustained, direct Iranian attack on Israel. On Israel’s actions, I will flag our Navigator Watchlist mention of “greyzone” military actions—remaining below the threshold of full-scale military conflict-- and say that I don’t think Netanyahu is ready to take such dramatic action in the weeks ahead of US elections. On Iran, the logic of PQ suggests that Tehran is more likely to exercise its tradition of “strategic patience”. Why? Because what Tehran wants most is to resume the P5 +1 nuclear agreement that it believes would follow a Harris/Walz administration. (President Trump withdrew the US from this agreement). It wants this so much that there are numerous credible reports that Tehran is among the actors behind the hacks into the Trump campaign, and possibly assassination attempts. Other factors impacting Tehran’s strategic calculus include the heightened US military presence in the Gulf.  

Israeli Prime Minister Netanyahu made an appeal directly to the people of Iran in a televised address that is well worth watching, referring to “our two great ancient peoples”. Netanyahu also suggested that change was coming to the Iranian regime faster than was expected.

I am not convinced about this. It reminds me of former US Secretary of State Condoleeza Rice’s hopeful but misplaced remarks during the Arab Spring, calling it “the birth pangs of a new Middle East”. To be sure, if Hamas and Hezbollah are genuinely diminished in their capacity to inflict damage to Israel and to other countries in the region, it would change the political architecture of the Middle East considerably. The history of “decapitation” attacks on terrorist organisations is unfortunately not supportive of this thesis.

Meanwhile, Iran retains a nuclear programme that is regarded as near breakout capacity, sufficient arms to overwhelm Israel’s Iron Dome and continues to send drones to Russia for use against Ukraine. Iran’s proxies may have been undermined, but Iran itself retains significant firepower. In the meantime, Saudi Arabia remains willing to do a deal with Israel, despite the war in Gaza.

It will be some time before we have a clearer view, but I am not minded to believe that Iran has changed its stance toward Israel or its neighbours, but rather that it will carefully choose its moment. For the short-term, Netanyahu has indeed bought himself some time with the success of the attacks as Israel heads into what will be an emotional 1-year anniversary on October 7th of the Hamas attacks, with many Israeli hostages still in captivity and others displaced from their homes in northern Israel.

Prime Minister Netanyahu’s Address to the People of Iran

Meanwhile, Populism is Making Gains in Europe…

Other developments we are tracking include the election result in Austria, which has seen the far-right Freedom Party surpass mainstream parties with 29% of the vote, taking first place. This result follows the strong performance in several German provinces by the far-right AfD. Both parties have neo-Nazi leaders associated with the parties, and in both cases, mainstream parties have vowed to block the far-right by refusing to serve with them in coalition. Recall that a similar result took place in France, with mainstream parties rallying to keep the far-right National Rally out of power (and Marine Le Pen today in court over allegations of spending impropriety).

This outcome often strikes Americans and those accustomed to “winner take all” systems as unfair, but is part of what differentiates multi-party parliamentary systems from presidential. Even given their likely constraints in governing, the strong performance of extreme populist parties in Europe should not be taken lightly. Between their performance in June’s European Parliamentary elections and German regional and Austrian national elections (not to mention earlier victories in Sweden and the Netherlands), European populist parties are seeing a spike in popularity, mainly on the back of immigration concerns. The rubber will really hit the road during the next round of major national elections: France in 2027 (can be called earlier) and Germany in 2025.

Latest US Polls and VP Debate Tuesday Night: Walz and Vance at the OK Corral?

Conventional Wisdom is that debates don't matter, and VP debates even less. But we have seen most of the standard conventional wisdom fall away in the case of US 2024 elections. The first presidential debate was a pivotal event, and although the second debate--the first between Harris and Trump--didn't prompt a boost for either, it provided American voters with their first opportunity for a side-by-side comparison after Harris rose to the top of the Democratic ticket and showed that she could hold her own against former President Trump, with a majority concluding that Harris “won” the debate.

In the final 5 weeks, the race remains a dead heat, with Harris having a slight edge in all 7 swing states, but squarely within the margin of error. This is very unusual, it has to be said, and also means that a slight shift in either direction could mean a “domino effect” victory for either candidate. Pollsters and prognosticators are fighting it out online—one observer remarked it was like “watching 2 wizards bickering”. Allan Lichtman of the 13 keys predicts a Harris victory  (he claims to have accurately predicted all but one of the past 8 US elections), and until recently, Nate Silver (who is now linked with the Peter Thiel-funded political gambling platform PolyMarket) had been leaning Trump with his model. Gallup published an article today stating that due to GOP issue advantages (immigration) and “economic pessimism”, the 2024 election environment is “favourable to the GOP” 

In short, there is a survey, a model and a pundit for every partisan taste, and very little of substance for those trying to make practical decisions. The race is on a knife edge, with very little movement in either direction. What worries me is that any falling political debris, such as a scandal, or disaster like Hurricane Helena but worse and closer to the election, could influence the direction of the tens of thousands of deciding votes in swing states. It also makes fertile ground for those who wish to interfere in the electoral process.

I don't expect the VP debate Tuesday night to be the event that causes polls to break out of their holding pattern, but this showdown between Tim Walz and JD Vance is still consequential, especially for Vance, given Trump's advanced age and his arguably higher likelihood of taking over the presidency in the event of Trump's death or incapacitation. But can anything emerge that is more startling than “they’re eating the cats/the people that live there” words that we heard from Donald Trump, who still polls at 49%? Both candidates have a few goals: defend their boss from attacks, defend their own records, and ideally, land a few solid rhetorical punches—but without looking like a jerk. In a race this close, a one point move can decide the outcome, so I’m not willing to say any data point is irrelevant.

In the past few weeks, I have spoken at and attended a number of US-election themed events in London and various European capitals and had the opportunity to speak with several heads of trading, banking and government affairs at leading financial institutions, as well as investors and private wealth clients. What strikes me is that few appear to have given much thought to what a Harris administration might look like, apart from rather simplistic assumptions about higher taxes under a Harris administration. They may be in for a surprise.

Reminder that we expect delays in certification and other wild cards between November 5th and Inauguration Day January 20th, 2025.

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