U.S. markets closed

Warning: War with ISIS will spook financial markets

The drumbeat for a U.S.-led war with ISIS is growing louder, and the coalition of countries vowing to destroy the group is growing in number after British aid worker David Haines was beheaded, the latest in a series of brutal murders. Haines’ beheading follows the murders of two American journalists, James Foley and Steven Sotloff.

British Prime Minister David Cameron said his country will do whatever is necessary to combat the Islamic State.

"We have to confront this menace. Step by step, we must drive back, dismantle and ultimately destroy ISIL and what it stands for," said Mr. Cameron. "As this strategy intensifies, we are ready to take whatever steps are necessary to deal with this threat and keep our country safe."

U.S. officials also took to the Sunday talk shows over the weekend to make the case for military action against ISIS.

Secretary of State John Kerry went on CBS’ Face the Nation and emphasized the coalition of countries prepared to strike Iraq and Syria.

“I can tell you right here and now, that we have countries in this region, countries outside of this region, in addition to the United States, all of whom are prepared to engage in military assistance, in actual strikes if that is what it requires,” he said.

President Obama last week emphasized that U.S. combat forces would not be part of his strategy to “degrade and destroy” ISIS. Referring to an additional 475 service members he is sending to Iraq, the president said, “these American forces will not have a combat mission –- we will not get dragged into another ground war in Iraq.”

But former director of the CIA, Michael Hayden, and some retired U.S. generals believe ground forces will be necessary. Hayden predicted on Fox News Sunday that as many as 5,000 U.S. personnel would be on the ground in the war against ISIS by the end of the year.

Market reaction to escalation

In recent months, the financial markets have had little reaction to geopolitical crises – such as the conflict between Russia and Ukraine. But an escalation in the war with ISIS could be a catalyst to change that, according to David Stockman, former director of the Office of Management and Budget and author of The Great Deformation: The Corruption of Capitalism in America.

Yahoo Finance spoke with Stockman and noted economist and Professor at the University of Texas at Austin, James Galbraith about what war with ISIS will mean for the markets and the U.S. economy.

“I think we’re stepping into a hornet’s nest that will create endless problems as we stumble down the road and elicit one kind of blowback after another,” said Stockman. “It will create the opportunity for unexpected turns in events that will spook the financial markets from time to time, and of course, it will distract Washington from addressing any of the economic or fiscal problems confronting the nation.”

Professor Galbraith takes a broader view on the post-Cold War realities the United States is facing and the challenges ahead for policymakers.

“The larger environment of world stability created by the United States in the Cold War and after the Cold War is coming apart,” he said.

Stockman warns that instability, when combined with a shift in Fed policy away from easy money will cause the markets to refocus attention on foreign events in the way they haven’t in recent months.

“As the markets begin to adjust and re-price and contemplate a future where the Fed is not just pouring liquidity onto Wall Street every day, I think news events that were ignored in the past may become the catalyst or the excuse for major selloffs, off and on, as we go forward.”


Why markets ignore 'geopolitical and geo-economic peril': Martin Wolf explains

Scottish independence could mean the end of Spain: Martin Wolf