Q&A: As Iran Conflict Continues, Volatility Is Up
- 5 hours ago
- 9 min read
Oil Spikes Above $100, While Equities and Bonds Drop
As week two of the US-Iran conflict gets underway, volatility remains elevated—futures point to a potentially steep drop today—amid ongoing military action across the region. Building on last Monday’s commentary, below we outline how we envision the conflict’s endgame and assess the implications for the economy, bonds, and equities.
So far, price action across major asset classes has largely mirrored patterns seen during past periods of geopolitical stress. And, to reiterate our main message during times of uncertainty: don’t let volatility or fast-moving headlines derail your long-term investing plans.
HOW LONG COULD THE CONFLICT LAST, AND HOW MIGHT IT END?
Forecasting geopolitical outcomes is inherently difficult. Decisions made by individual leaders—while rooted in strategic cost-benefit analysis—are also shaped by emotion, domestic pressures, and shifting battlefield realities. With that uncertainty in mind, here is our base case outlook for the conflict.
The conflict is unlikely to become a prolonged war akin to Iraq or Russia’s invasion of
Ukraine. With the White House showing no interest in a ground invasion of Iran, US operations will likely remain limited to an air campaign. Our base case assumes a three-to-four-week conflict, as a longer military engagement would pose political risks for President Trump in a midterm election year. The administration’s end goal is also deliberately vague, giving the president flexibility to declare‘mission accomplished’ at any time.
The White House will be influenced by both economic and political considerations. Oil prices have posted their largest weekly spike on record, pushing retail gasoline prices to $3.45/gallon. Global equity markets have come under pressure. Early polling on the war suggests that more Americans oppose the conflict than support it—and any rise in US casualties would likely intensify political pushback.
Iran is unlikely to capitulate, but it will seek an off-ramp. Like Washington, Tehran does not want a drawn-out conflict that it cannot afford. Militarily, Iran is at a disadvantage—despite a large army on paper, its capabilities—particularly in air defense and missile systems—are far weaker than those of the US. Economically, near-zero oil exports have cut off a vital source of revenue. And although the regime has shown resilience—for example, naming a new Supreme Leader this past weekend—an outright surrender is unlikely. Notably, Iran briefly hinted at de-escalation this weekend, saying it would pause attacks on neighbors unless provoked—but subsequently walked back that position.
WHAT HAS BEEN THE MARKET IMPACT?
Market volatility has picked up, though largely in predictable ways. Unsurprisingly, energy prices have seen the biggest move— oil has soared to a four-year high of more than $100/barrel, though the futures curve points to prices cooling in the coming months.
International equities have lagged US markets over the past five trading sessions. The US dollar has edged higher, reflecting the US economy’s lower exposure to energy supply risk. And counterintuitively, gold is roughly unchanged, while most industrial metals have declined.
WHAT’S THE LATEST ON THE OIL MARKET?
When we published our report one week ago, there were already clear signs that the conflict was spreading across the region, driven by Iran’s retaliation against neighboring countries. Iranian missiles or drones have struck at least 11 countries in the region. Over the past week, the full extent of the disruption to Persian Gulf oil flows has become evident. Under normal circumstances, one-fifth of global oil supply moves through the Persian Gulf’s Strait of Hormuz, with most shipments bound for Asian markets. But now, tanker traffic has ground to a halt as shipping companies and their insurers are unwilling to put vessels and their crews in the conflict zone. As storage tanks in countries such as Iraq and Kuwait reach capacity, production is being shut down. Meanwhile, energy facilities in Iran as well as its neighbors have come under attack, and there is a risk that further escalation could see more widespread damage to the region’s energy infrastructure.
Last week’s 36% spike in WTI crude—the largest weekly increase since oil futures trading began in 1983— followed by a further jump to more than $100/barrel in early Monday trading—signals a growing urgency for additional supply. Fortunately, policymakers have an immediate tool at their disposal: emergency oil reserves. These government-controlled stockpiles, such as the US Strategic Petroleum Reserve, sit above and beyond ordinary commercial inventories and can be released at any time. The US and its allies—part of the International Energy Agency (IEA)—hold 1.2 billion barrels in emergency reserves, equating to ~200 days worth of imports from the Persian Gulf.
Outside the IEA, China also maintains a sizeable stockpile. During the last geopolitical energy shock—Russia’s 2022 invasion of Ukraine—the IEA coordinated a joint multimonth release of reserves that helped cool prices. The most import-dependent nations, including Japan and South Korea, could act unilaterally, while a broader effort is organized.
Concerns about fuel shortages are premature, even if the conflict were to extend beyond March. Moreover, the oil futures curve signals easing prices after April, suggesting that industry buyers view today’s elevated levels as unsustainable—we agree. We expect the price spike to be temporary and maintain our year-end target of $55-$60 for WTI.
WHAT ABOUT THE IMPACT ON OTHER COMMODITIES?
In addition to oil, the Persian Gulf region—mainly Qatar—accounts for one-fifth of the world’s supply of liquefied natural gas (LNG), which is also predominantly exported to countries in Asia. The same supply disruption is occurring in LNG: tankers cannot get in and out to deliver. While there are natural gas inventories that can be tapped, they are typically smaller than what’s been built out for oil. Finally, the region is a key source of urea fertilizer, used by farmers around the world. Three of the world’s top four urea exporters—Oman, Qatar, and Saudi Arabia—are facing the same shipping disruptions that are also affecting oil and gas. Higher costs for farmers may translateinto higher food prices in the near term.
DOES THE CONFLICT CHANGE OUR OUTLOOK FOR THE US ECONOMY?
The short answer is no—provided that the conflict is relatively brief (our base case is roughly three-to-four weeks), and financial markets avoid a sustained sell-off. While the US is a net exporter of oil, US consumers and businesses are not immune to the increase in oil prices. For every $10/barrel increase in oil, gasoline rises by $0.25/gallon, all else being equal. A temporary uptick in inflation is likely, but as long as the conflict does not extend for several months, we expect those pressures to fade. Once the conflict ends, we expect the broader trend of cooling inflation to resume later in the year.
Equally important, we do not anticipate a material slowdown in consumer spending unless equity markets were to experience a meaningful and prolonged decline. Healthy increases in tax refunds should support spending in the interim, offsetting the increase in fuel prices. Over the past year, strong market performance has bolstered the wealth effect and, in turn, consumer activity. Absent a double-digit equity decline that undermines confidence and spending, the macro impact should remain modest.
COULD THE CONFLICT ALTER THE TRAJECTORY FOR THE FED’S POLICY?
Again, the answer is no. Any near-term uptick in inflation resulting in higher oil prices is likely to be transitory and should not meaningfully influence the Fed’s reaction function. Historically, the Fed has looked through geopolitically driven energy shocks, particularly when they do not feed into longer-term inflation expectations. However, given the short-term inflation boost, market expectations for Fed rate cuts this year have already been scaled back. Our baseline remains that the Fed will cut rates one time by 25 bps this year, driven primarily by sluggish labor market conditions. Importantly, policymakers are likely to place greater weight on underlying (core) inflation trends rather than temporary headline volatility. This approach will allow Fed officials to remain focused on sustaining the expansion rather than responding to short-term geopolitical disruptions.
WILL INTEREST RATES CONTINUE TO MOVE HIGHER?
Near-term risks remain tilted to the upside until the geopolitical uncertainty fades or energy prices stabilize. That said, yields have already moved significantly, with the 10-year Treasury yield rising from its recent low of 3.94% to 4.20% early Monday morning. From the bond market’s perspective, the jump in oil prices represents both a volatility and a supply shock. As higher oil prices feed directly into headline inflation and near-term inflation expectations, Treasury yields have moved sharply higher across the curve. Yields have also drifted higher as markets increasingly push back the timing and likelihood of Fed rate cuts while inflation remains elevated. Absent a negative growth shock, policymakers are likely to stay on the sidelines while they assess the longer-term implications.
While developments in the Middle East continue to evolve, the key swing factor for the rate outlook remains oil—specifically the persistence of higher oil prices. The longer the conflict drags on, the greater the risk of broader economic strain. Friday’s unexpectedly weak jobs report—even if weather and strike-related—was an important reminder that underlying fundamentals still matter. That said, our base case remains that the conflict will last weeks, rather than months, which should limit the downside risks to the economy and help keep long-term inflation expectations wellanchored. As a result, we are not inclined to adjust our year-end 10-year yield forecast of 4.25%-4.50%. However, if yields reached the upperend of our year-end target, we would be inclined to add duration.
DOES THE CONFLICT CHANGE OUR VIEWS ON US EQUITIES?
Based on overnight signals from the futures markets, the S&P 500 is set to open ~5% below its recent high for the first time since last November. While market pullbacks are never comfortable, it is important to remember that volatility is part of the fabric of the market. Historically, the S&P 500 experiences three to four 5% or more pullbacks a year, with an average maximum intra-year decline of roughly 14%.
While our base case remains that this war will be short-lived, the path forward remains highly uncertain. A more prolonged conflict would raise the risk of a deeper drawdown. Although it is not our base case, a sustained increase in oil prices is the biggest risk to the market, as it increases the chances of higher inflation and interest rates, and further tightening from the Fed. With valuations stretched and investor equity allocations near record highs, any of these factors would weigh on both valuations and sentiment.
Although near-term volatility may increase as the conflict unfolds, if the conflict and the rise in oil prices prove to be short-term in nature, in line with our base case, fundamentals (e.g., positive EPS and sales growth) remain supportive of the market overall. As a result, we maintain our year-end S&P 500 target of 7,250 as the conflict does not derail our long-term constructiveequity view for a few reasons:
Geopolitical Unrest Tends To Be Short-Lived—Historically, volatility stemming from geopolitical events has proven to be temporary. Dating back to 1990, the S&P 500 has risen ~8% on average in the 12 months following a major geopolitical event. In most instances, equity market volatility has not been long-lasting unless the event coincided with a recession. Because a recession is not our base case, we remain confident that any equity volatility tied to the current conflict is likely to be short-lived.
Limited Revenue Exposure To The Middle East—S&P 500 companies have minimal direct revenue exposure to affected regions. Only 0.1% of index revenues come from Iran, and ~2.5% of revenues come from the broader Middle East region. This limited index footprint helps contain the potential downside risk to overallearnings and reduces the likelihood of a meaningful profit impact from the conflict.
Record Margins Help Cushion Higher Input Costs—S&P 500 companies are entering this period from a position of strength. Margins are projected to reach a record high of ~14% in 2026, providing a substantial buffer should input costs increase materially. In addition, companies have demonstrated an ability to pass higher costs to consumers in recent years. While the war introduces some downside risks— particularly for consumer-focused names if higher gas prices dampen spending—we currently expect S&P 500 earnings to increase 10%-12% YoY in 2026 ($300 EPS). This outlook provides room for modest downside relativeto the current consensus estimates of 14% earnings growth ($311).
WHAT ABOUT INTERNATIONAL EQUITIES?
The fallout from the conflict has triggered broad-based equity declines—a classic risk-off reaction to rising geopolitical uncertainty. However, the pullback has been more pronounced in Europe and Asia, where economies are considerably more dependent on imported energy. Since the airstrikes began, the S&P 500 has fallen a relatively modest 2.0%. By contrast, the MSCI Europe Index is down roughly 7%, while the MSCI Asia Pacific Index is down about 6% in USD terms—marking their worst five-day relative performance to the S&P 500 since last April. Part of this move likely reflects some position squaring after a sustained period of outperformance.
While we view a prolonged energy supply shock as a low-probability outcome, sentiment toward Europe and Asia will likely stay cautious until there is greater clarity on the endgame in Iran. Looking ahead, we remain constructive on Asian emerging markets where fundamentals—particularly given the region’s strong upward earnings momentum—remain supportive, and valuations continue to look attractiverelativeto other developed markets.
BOTTOM LINE
We expect the conflict to be relatively short-lived, with a resolution or de-escalation likely in the coming weeks. As tensions ease, energy supplies and shipping should normalize, and prices should begin to retreat, helping limit the broader economic and market impact.
While volatility may persist in the near term, investors are best served by staying disciplined and focused on their long-term goals.
All expressions of opinion are those of Investment Strategy and are subject to change. This information should not be construed as a recommendation. The foregoing content is subject to change at any time without notice. Content provided herein is for informational purposes only. There is no guarantee that these statements, opinions or forecasts provided herein will prove to be correct. Past performance is not a guarantee of future results. Indices and peer groups are not available for direct investment. Any investor who attempts to mimic the performance of an index or peer group would incur fees and expenses that would reduce returns. No investment strategy can guarantee success. Economic and market conditions are subject to change. Investing involves risks including the possible loss of capital. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Diversification and asset allocation do not ensure a profit or protect against a loss. Investing in oil involves special risks, including the potential adverse effects of state and federal regulation and may not be suitable for all investors.
Comments