- Market reactions to the Israel-Hamas war imply investors think the conflict will be contained, Mohamed El-Erian said.
- But any expansion in hostilities could weaken global economic growth as inflation ramps up, he told CNBC.
The war that erupted this weekend between Israel and Hamas militants has so far led to relatively reserved market reactions, economist Mohamed El-Erian said on CNBC.
That's because investors are treating the conflict as contained, but any enlargement to the hostilities could force a rethink, he cautioned.
"If this expands and brings in other parties, then the outlook is for even a weaker global economy, even more inflationary pressures. And the markets are going to be finding it hard to deal with that," he said Monday.
It may also raise geopolitical uncertainty in general, El-Erian added: "What's gonna happen with Ukraine at this point, and Russia? What's going to happen with China? So this is why the big question for the markets and for the economy is whether you get escalation."
On Sunday, Israel declared war on Hamas, after the Palestinian militant group launched a series of surprise attacks on the nation the day before. In response, oil prices spiked as much as 5% on Monday, while gold and the dollar also moved up.
The war could widen as reports emerged that Iran helped Hamas plan its attacks on Israel offensive.
El-Erian laid out a scenario where Israel retaliates against Iran, which then gets engaged more directly in the conflict, with Syria and Lebanon also becoming more active too.
"And then you've got a significant war going on," he said.
Market veteran Ed Yardeni shared a similar concern in a weekend note, pointing out that the price of oil may be an effective way of assessing the possibility of a broader conflict. He currently views a further flare-up as unlikely, noting that crude prices remain weak after third-quarter highs.
But if oil prices continue rising, bond yields could climb further and could send the S&P 500 below its 200-day moving average, Yardeni said.
"However, the solid Q3 earnings reporting season we expect should reduce the near-term downside and increase the upside in a year-end rally, which we also still expect," he wrote.