Oil prices, defense stocks climb after Israel declares war

>> Oil prices are climbing, and stocks are edging higher in unsteady trading Monday as violence in the Middle East injects more caution into financial markets.

The S&P 500 was 0.6% higher in its first trading since Hamas launched a surprise attack against Israel, which then formally declared war. Trading has been unsteady, with the benchmark index falling as much as 0.6% earlier.

The Dow Jones Industrial Average was up 169 points, or 0.5%, as of 2:01 p.m. Eastern time, and the Nasdaq composite was 0.4% higher.

The area under conflict is not home to major oil production, but fears that the fighting could spill into the politics around the crude market sent a barrel of U.S. oil up 4.1% to $86.16. Brent crude, the international standard, rose 3.9% to $87.91 per barrel.

One potential outcome is a slowdown in Iranian oil exports, which have been growing this year, according to Barclays energy analyst Amarpreet Singh. Less supply of crude would raise its price, all else equal.

The conflict could also hurt the possibility of potential improvement in relations between Israel and Saudi Arabia, which is the world's second-largest producer of oil. Traders may be taking off some bets that Saudi Arabia would raise its oil output to help secure a deal on Israel with the United States, according to Singh.

Oil prices had already been volatile leading into the weekend. A barrel of U.S. crude jumped from less than $70 during the summer to more than $90 last week, raising the pressure on inflation and the overall economy. It pulled back sharply last week before jumping again after the fighting began in Israel.

Monday's rise in crude helped oil and gas stocks to some of Wall Street's biggest gains. Marathon Oil rose 6.5%, and Halliburton climbed 6.4%.

Stocks of defense contractors that make weapons were also particularly strong. Northrop Grumman rallied 11.5%, and Lockheed

Martin gained 8.3%.

On the opposite end were companies that count fuel as among their biggest expenses. American Airlines sank 4.2%, and Norwegian Cruse Line fell 2%.

Major airlines have suspended flights to Israel as the U.S. State Department issued travel advisories for the region citing potential for terrorism and civil unrest.

The U.S. stock market broadly has been shaky since the end of July, weighed down by the pressure of much higher yields in the bond market.

With inflation still too high for policy makers' liking, and the U.S. economy in solid shape, expectations have built on Wall Street that the Federal Reserve will keep its main interest rate high for longer than traders had hoped.

The Fed has already hiked its overnight rate to the highest level since 2001, and it indicated last month it may cut rates next year by less than earlier expected. With the Fed also continuing to shrink its trove of bond investments, the yield on the 10-year Treasury has jumped to its highest level since 2007.

Wall Street hates higher interest rates because they knock down prices for stocks and other investments. They also make it more expensive for all kinds of companies and households to borrow money, which puts the brakes on the economy.

Such a rise could lead to a hit of half a percentage point to the U.S. economy's growth next year, according to economists at Goldman Sachs. They call it a meaningful change, but too small to cause a recession.

For investments, higher yields could also mean a reset in how much investors are willing to pay for stocks of money-losing companies, said David Mericle and Ronnie Walker. Many investors were happy to pay high prices and wait a long time for growth to come to fruition because 10-year yields were so low. But will they when they can make nearly 5% instead?

The 10-year yield has climbed to 4.80%, up from 3.50% during the summer and from just 0.50% early in the pandemic.