The intensifying conflict between the United States and Iran over the weekend has prompted Wall Street to reassess the potential economic fallout from the hostilities.
While the US stock market showed a muted immediate reaction to the latest geopolitical tensions, economists are increasingly concerned that rising energy prices could dampen consumer spending and weigh on the broader economy.
US-Iran Conflict Escalates, Economic Repercussions Analyzed
The recent escalation in clashes between the US and Iran has led to a fresh evaluation of the economic consequences by financial analysts. Following the Houthi rebels' declaration of a maritime blockade against Saudi Arabia, the US concluded its tenth consecutive night of strikes against Iran on Monday. The conflict has now resulted in the deaths of three American service members, suggesting the potential for a prolonged and more costly phase. Former President Donald Trump signaled a firm response, stating on social media that retaliation is certain and that "they will pay a price."
Market's Initial Calm Belies Underlying Risks
Investors currently do not appear overly alarmed by the geopolitical strife. The S&P 500 index, after closing lower last week, experienced only a minor decline on Monday and remains within 2% of its record high set in June. However, economists warn that sustained increases in energy costs will pressure both household budgets and macroeconomic performance.
Duration of Conflict Seen as Key Factor
The overall impact on equity markets from the Middle East conflict has been limited so far. The S&P 500 rebounded strongly from a low in late March to reach new highs, largely driven by the prevailing market view that neither the US nor Iran desires a full-scale war, which would inflict significant damage on the global economy and both nations.
Investor focus has recently shifted back to corporate fundamentals, with a robust Q2 earnings season and softer-than-expected inflation data last week boosting risk appetite.
Nonetheless, two persistent risks cannot be ignored: surging oil prices and rising US Treasury yields. Brent crude oil briefly surpassed $90 per barrel on Monday and hovered below that level on Tuesday. Meanwhile, the yield on the 10-year US Treasury note breached the key 4.6% level watched by traders on Monday and remained near that mark on Tuesday.
If oil prices and the 10-year yield continue to climb or remain elevated for longer than anticipated, Wall Street may be forced to revise inflation expectations higher and reprice the risks of tighter monetary policy, ultimately eroding corporate profits.
Art Hogan, Chief Market Strategist at B. Riley Wealth, stated, "The key is how long this lasts. If oil prices stay in the $85 to $90 range through year-end, it's likely we'll see downward revisions to full-year earnings estimates."
Hogan noted that in an extreme scenario, the S&P 500 could face a correction (a drop of more than 10% from its peak), but the broader market would find support from the technology sector, which has the highest weighting in the index and is less directly impacted by high oil prices. According to S&P Global data, technology stocks account for 38% of the index, compared to just 3% for the energy sector.
Sectors like financials and healthcare also possess strong long-term growth narratives and are less susceptible to oil price headwinds. Conversely, the energy sector and fuel-dependent logistics companies are expected to underperform. For instance, Ryanair reported on Monday that the Middle East crisis had led to a slowdown in ticket bookings, resulting in weak quarterly profits.
The market is closely monitoring whether the Middle East situation will deteriorate further, potentially leading to a blockade of the Strait of Hormuz, a critical global oil shipping chokepoint.
Marco Papic, a Geostrategist at BCA Research, is tracking two key variables: whether hardline factions in Iran gain influence and whether the US deploys additional troops to the Middle East.
However, some institutions remain bullish on the market outlook, betting on a de-escalation of geopolitical tensions in the second half of the year. Mislav Matejka, an analyst at JPMorgan, has maintained a strategy since late March of using market dips caused by conflict to add to equity positions.
He wrote in a recent note, "We continue to advise investors to use any market pullbacks on geopolitical newsflow to add to equities. The market is getting increasingly better at pricing geopolitical risks as temporary disturbances."
Economic Impact: Broadly Negative with No Upside
Economists fear that the conflict-driven surge in fuel prices will broadly suppress US consumer spending and the services sector.
Mark Zandi, Chief Economist at Moody's Analytics, stated plainly, "This is all bad, no good for the US or global economy. The ultimate impact depends entirely on how the situation evolves and how much prices rise for oil and other commodities, but the overall effect is entirely negative."
Zandi estimates that the combined effect of war-induced energy price increases and higher military spending could cost the average American household around $1,100. In recent months, real disposable income growth has nearly stalled or turned negative, a pattern typically seen during economic recessions.
With rising oil prices, American consumers are forced to dip into savings to maintain spending, but this buffer is being depleted rapidly. Data from the Bureau of Economic Analysis shows the personal savings rate was just 3% in May, down nearly 2 percentage points year-over-year.
According to AAA, the national average retail price for gasoline returned to $4 per gallon on Monday for the first time in a month.
Economists predict that the rebound in oil prices will directly push the Consumer Price Index (CPI) higher. While May's year-over-year CPI increase was the highest in three years and moderated slightly last month as energy costs eased, core CPI (which excludes volatile food and energy prices) may not follow the same upward trajectory. This could alleviate pressure on the Federal Reserve to raise interest rates. The CME FedWatch Tool indicates an over 83% probability that the Fed will keep rates unchanged at its meeting next week.
Luke Tilley, Chief Economist at Wilmington Trust and M&T Bank, noted, "Higher gasoline prices will boost the overall inflation reading, but all Fed officials are clearly focused on one core question: will the price increases spread to core inflation?"
Michael Gunther, an analyst at Consumer Edge Research, pointed out that if oil prices remain elevated long-term, businesses catering to budget-conscious, car-dependent customers, such as Dollar General, Tractor Supply, and Texas Roadhouse, could see a significant drop in foot traffic.
Conversely, warehouse clubs like Costco could gain market share as consumers consolidate shopping trips to save on fuel. Costco reported record fuel sales at the end of its fiscal quarter, partly driven by war-related price increases.
"Consumers are very sensitive to gas prices and are actively changing their behavior to save money," Gunther said.
Retail data suggests that consumers are continuing to spend despite the cost pressures from the conflict, though temporary factors like the World Cup boosting ticket and gambling spending have provided a special lift.
Heather Long, Chief Economist at Navy Federal Credit Union, added that tax refunds from previous legislation provided a buffer for consumer spending early in the conflict. However, if oil prices rise again in the second half of the year, consumers will lack this support.
"The consumer buffer is being depleted quickly, and there's nothing else positive on the horizon to cushion the blow," Long concluded.
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