Investors are watching for signs that the conflict in the Middle East may be escalate over the weekend, potentially ratcheting up volatility as investors await a Federal Reserve meeting and key U.S. data in the week ahead.

Prime Minister Benjamin Netanyahu said on Saturday that Israeli forces had unleashed the second phase of the Gaza war as they pressed ground operations against Hamas militants.

Investors have grown more worried about a widening conflict in recent days after the U.S. dispatched more military assets to the Middle East while Israel attacked targets in Gaza and Hamas supporters in Lebanon and Syria.

"The situation in Israel is … causing a lot of anxiety,” said Randy Frederick, managing director of trading and derivatives for Charles Schwab.

On Friday, Brent futures settled up 2.9% at $90.48 a barrel on concerns the conflict could disrupt crude supplies. Spot gold , a popular safe haven for nervous investors, vaulted over $2,000 for the first time since mid-May.

In a note on Friday, analysts at Capital Economics said the oil market's response to the conflict was "muted" so far.

"That said, any sign that the other countries in the region are becoming more involved in the conflict would cause oil prices to rise sharply," they wrote.

If an escalation of the conflict causes the U.S. to increase war-related spending that raises the deficit, Treasury yields could rise beyond the 16-year highs they already have hit, said Peter Cardillo, chief market economist at Spartan Capital Securities.

Some investors also expect a widening conflict could prompt safe-haven buying of Treasuries. This could moderate the surge in yields, which move inversely to prices, and this in turn could ease pressure on stocks and other assets.

The S&P 500 has fallen more than 10% since late July, when it reached its high for 2023, though the index is up over 7% year-to-date.

"So far, U.S. government bonds have not been performing their usual safe-haven function," UBS Global Wealth Management said in a note on Friday. "However, an escalation of the conflict would likely shift attention away from monetary policy concerns and boost safe-haven demand for Treasuries."

Both gold and oil can also provide hedges against near-term volatility, they said.

The Cboe Volatility index (.VIX) has climbed in the wake of the conflict and rose on Friday, approaching seven-month highs.

The Federal Reserve is set to give its latest monetary policy statement on Wednesday, while Apple's quarterly results highlights another busy week of corporate reports.

Reuters