Key Takeaways:
KSG assesses that a ceasefire in the next six months is unlikely, as Israel invaded southern Lebanon with 20,000 troops to dismantle Hizbullah’s rocket capabilities and establish a security buffer along its border.
Israel is highly likely to retaliate against Iran but avoid targeting its nuclear and oil facilities as regional dynamics, including Saudi and GCC pressures, aim to prevent escalation.
Iran is likely to accelerate its nuclear program as its traditional deterrents, Hamas and Hizbullah, have been severely weakened by Israeli military operations.
Israel’s tech sector has shown resilience despite the conflict, but struggles to attract new foreign investment, while traditional sectors face labour shortages due to reservist call-ups.
Oil prices briefly spiked following Iran’s missile attack, but have since stabilised, as global demand factors, particularly from China, outweigh Middle Eastern conflict concerns.
Significant Developments (past 30 days):
September 27: Israel assassinated Hizbullah chief Hassan Nasrallah in an airstrike. Six other senior Hizbullah leaders and a general in Iran’s Revolutionary Guard Corps (IRGC) elite Quds Force were also killed in the attack.
September 30: Israeli Defence Forces invaded southern Lebanon, in an operation to stop Hizbullah rockets and possible ground attacks into northern Israel. The IDF has since captured numerous stores of weapons and munitions staged in southern Lebanon.
October 1: Iran launched approximately 200 ballistic missiles at Israel, in retaliation for Israel’s killing of Nasrallah and Hamas leader Ismail Haniyeh in Tehran on 27 September and 31 July 2024, respectively. Most of the missiles were intercepted by Israeli and US forces, or fell short of their targets.
October 17: Israel announced the killing of Hamas leader Yahya Sinwar.
Israel Invades Southern Lebanon
The Israeli Defence Force (IDF) has invaded southern Lebanon with 20,000 soldiers to eliminate Hizbullah's rocket capabilities and create a buffer along the border, allowing 60,000 displaced civilians to return home. Following airstrikes and assassinations that disrupted Hizbullah's command, Israel expanded its strikes beyond southern Lebanon to Beirut's city centre, which the US opposes.
The conflict on two fronts—Gaza and Lebanon—has strained the IDF, with 360,000 reservists called up since the October 7th Hamas attack, leading to economic issues like staff shortages and a projected budget deficit of 7.8% of GDP for 2024. Fitch downgraded Israel's credit rating before the conflict expanded, and further downgrades are expected.
Continued Operations in Gaza
Despite shifting focus to Lebanon, Israel continues operations in Gaza claiming key successes, including dismantling Hamas' Rafah Brigade and securing the Egyptian border. The IDF has destroyed Hamas’ tunnel network but maintains a presence in Gaza as skirmishes suggest ongoing infiltration by Hamas. KSG assesses that Israeli forces will maintain an extensive presence in Gaza for at least the next six months.
Washington Continues Push for Peace
The US continues to push for a cease-fire despite escalating conflict, and implementing UNSCR 1701, calling for a withdrawal of forces from southern Lebanon with diplomats from the US and France leading discussions at the UN General Assembly. While Israel and Hamas have agreed to parts of Washington’s proposal, the US sees Hamas as the main obstacle to a cease-fire deal.
Israel’s Response to Iranian Missile Attack
Israel is yet to respond to Iran’s attack on its sovereign territory. KSG assesses that Israel will retaliate for the attack on targets and in a manner calculated to restore deterrence vis-a-via the Islamic Republic, yet avoid escalation to a full-scale war. In addition, KSG also assesses that Tehran, having observed Israel’s ability to precisely strike targets of its choosing even deep in adversary territory, likely does not want to risk being drawn into a conflict that could also include the US.
Looking forward
Diplomatic & Military Situation
KSG assesses that Israel’s ground incursion into Lebanon and its targeted strikes against Hizbullah leadership and infrastructure have achieved their mission - to inhibit the group’s ability to conduct a sophisticated ground invasion against Israel. KSG wargaming concluded that it will require at least two years to rebuild its leadership structure and re-arm. It is unlikely that Israel will achieve its stated goal of eradicating Hizbullah (and Hamas) entirely, as they remain deeply embedded in their respective societies.
Israel's killing of Hamas leader Yahya Sinwar is viewed as an opportunity by the US to renew efforts for a ceasefire. With the US Presidential election approaching on November 5th, Biden is eager to reduce tensions in the Middle East, hoping for a diplomatic breakthrough before the possible re-election of Donald Trump. However, KSG assesses that these efforts are highly likely to be unsuccessful as PM Netanyahu waits to see if Trump wins a second term. In Trump, Netanyahu sees a closer ally who is likely to be much less critical of Israel's conduct in Gaza and southern Lebanon.
Following the IDF’s dismantling of Hamas and Hizbullah, KSG considers it likely that Iran will accelerate efforts to produce a nuclear warhead. Hamas and Hizbullah have proven a significant deterrence option for Iran over many years. If Israel was to strike Iranian territory, Tehran could press these groups to launch rockets and missiles at Israel. This deterrent has become obsolete.
In addition, KSG assesses that mutual support amongst the Axis of Resistance’s constituent groups is likely to diminish or fracture. Iran frequently reiterated that support for its proxies was steadfast, yet provided limited material support to Hamas when it was attacked by the IDF in the wake of the October 7th attacks. Hizbullah leadership also demonstrated hesitancy in defending Hamas. Prior to Israel’s invasion of its heartland in Southern Lebanon, and despite Hizbullah’s capabilities of striking high-value Israeli targets, its support of Hamas was piecemeal and did not attempt to cause the serious damage it is capable of causing. This demonstrates a hesitancy amongst its remaining leadership to escalate the conflict.
KSG assesses that Israel is likely to retaliate against Iran in the near term, but it is highly unlikely that these will target Iranian Nuclear or Oil facilities following assurances in this vein from Israel.
The likelihood that Saudi Arabia and Israel normalise relations remains low over the next six months. This is because the former prerequisites the establishment of an independent Palestinian state, whilst Israel is very likely to press on with its invasion of Southern Lebanon which is an obstacle to any ceasefire agreement. However, an accelerated Iranian nuclear weapons programme is likely to accelerate normalisation efforts.
Red Sea
Houthi rebels will almost certainly continue to strike ships in the Red Sea as Israel presses on with its operation against Hizbullah. Therefore, KSG considers it highly likely that maritime traffic in the Red Sea will remain diminished, thus keeping Egypt’s revenue stream from the Suez Canal low. Major shipping firms will continue to divert traffic around the Cape of Good Hope until at least Q1 of 2025, given current conditions remain in place.
Technology Sector
KSG assesses that further downgrades to Israel’s credit ratings are likely to occur. This is based on KSG’s assessment that the war is highly likely to continue until Spring 2025 at least which will continue to negatively affect the country’s economy.
The Israeli tech industry has remained resilient as Israel’s economy staggers due to the conflict. The tech industry has not shrunk, has maintained a steady level of total (foreign & domestic) investment, and been able to retain staff (unlike many other sectors). In comparison, traditional retail has had to contend with shortages as migrant labour from Palestine dried up and Israeli citizens spent extended periods in the reserves.
Energy
Oil prices only briefly spiked from nearly $70 a barrel to over $77 in the week following Iran’s missile attack. However, they quickly dropped following Israeli assurances that it would only strike military targets, suggesting that fears over supply side disruption were not warranted. Additionally, KSG assesses that price concerns will be more sensitive to demand based factors over the next 12 months. This is demonstrated by the prices falling further after OPEC made cuts to global oil demand growth for 2024 and 2025, driven by weak demand from China.
GCC states urged the US to restrain Israel from attacking Iranian oil facilities following Iran’s missile attack on Israel, demonstrating a shift in their macroeconomic mindset. Elevated oil prices would have benefited the oil producing GCC states, yet their lobbying of Washington suggests they value the stability of the wider region above immediate financial gain.
Defence Sector
Although Israel's prolonged conflict against Hamas and Hizbullah underscores the importance of a domestic military industrial complex, especially among GCC states and Turkey, Iran’s October 1st missile attack and the US stationing of a THAAD battery in Israel highlight critical issues in supply chains and mass ammunition production capabilities. The duration of the conflict underscores the complexities in replenishing cutting-edge weaponry, and proves that such weapons systems can be exhaustible even for well prepared states such as Israel. KSG assesses that states with growing domestic military production projects are highly likely to focus on the expansion of ammunition production as well as consolidating supply chains. Strategies in this vein are highly likely to involve the integration of commodities and technology firms as states seek to guarantee access to the full range of necessary components and raw materials.