Wall Street Reconsiders Economic Impact of Escalating U.S.-Iran Tensions as Oil Prices Spike

An F/A-18F Super Hornet, attached to Strike Fighter Squadron (VFA) 41, prepares to launch from the flight deck of Nimitz-class aircraft carrier USS Abraham Lincoln (CVN 72). Courtesy: U.S. Navy

A ramp-up in fighting between the U.S. and Iran over the weekend has left Wall Street reconsidering its expectations for the war’s economic impact. The U.S. completed its 10th straight night of strikes against Iran on Monday, after the Houthis in Yemen declared a maritime embargo against Saudi Arabia. This comes after a third service member died amid recent fighting, signaling that the conflict may be entering a longer-term and deadlier era. President Donald Trump vowed the U.S. would retaliate, stating in a Truth Social post, "they will pay."

Despite the escalating tensions, investors have largely brushed off the latest flareup. The S&P 500 index saw only a marginal decline in Monday’s trading session following a losing week and remains just 2% below its all-time high set in June. However, economists are increasingly concerned that rising energy prices could negatively affect consumers and the broader economy.

‘It’s About Duration’

The stock market’s resilience to the conflict in the Middle East has been notable. Since a closing low in late March, the S&P 500 has rallied to record highs, largely fueled by the assumption that neither the U.S. nor Iran desires a return to outright war, given the potential for a global recession. Investors have instead focused on fundamental economic factors, particularly the strengthening corporate earnings reported during the second-quarter earnings season. Additionally, softer-than-expected inflation data released last week contributed to investor optimism.

However, the recent surge in oil prices and rising bond yields are becoming increasingly difficult for investors to ignore. Brent crude briefly surpassed $90 a barrel on Monday and hovered just below that mark on Tuesday. The U.S. 10-year Treasury yield traded above 4.6% on Monday, a significant level for traders, and remained near that point on Tuesday. If crude oil prices and the 10-year Treasury yield continue to rise or remain elevated for an extended period, Wall Street may be compelled to factor in changes to inflation expectations and monetary policy that could eventually impact corporate bottom lines.

Art Hogan, chief market strategist at B. Riley Wealth, emphasized the importance of duration, stating, "It’s about duration. If we’re above $85 or $90 into the end of the year, I suspect that the earnings estimates for this year would have to be trimmed." Hogan suggested that in a worst-case scenario, the S&P 500 could enter a correction. He also noted that the broader index could be supported by the technology sector, its largest component, which is relatively insulated from higher energy prices. Technology accounts for 38% of the S&P 500’s weighting, compared to just 3% for energy, according to S&P Global.

Sectors such as financials and healthcare are also expected to benefit from long-term trends, irrespective of higher oil prices. Conversely, the energy sector and fuel-dependent logistics companies are likely to be the biggest laggards. Ryanair, for instance, reported that its weak first-quarter profits were influenced by delayed bookings attributed to the Middle East crisis.

The region’s developments will be closely monitored for any escalation that could disrupt passage through the Strait of Hormuz. Marko Papic, macro and geopolitical strategist at BCA Research, is observing whether Iran’s hardliners gain further influence or if the U.S. increases its troop deployment in the Middle East. Conversely, some analysts remain confident in the market, anticipating an improvement in the geopolitical outlook in the latter half of the year. Mislav Matejka of JPMorgan advocates for a strategy of adding exposure during dips caused by geopolitical headlines, believing the market has become adept at perceiving geopolitical risks as temporary.

‘All Downside’

Economists are expressing significant concern about the potential impact of rising fuel prices on U.S. consumers and the businesses that serve them. Mark Zandi, chief economist at Moody’s Analytics, stated, "There’s nothing but downside here for the U.S. and global economies. Obviously, a lot depends on exactly how this all plays out and what it means for oil and other commodity prices. But it’s all downside."

Zandi estimates that the average American household has lost approximately $1,100 to date due to the conflict, encompassing increased energy costs and higher military expenditures. This has led to real disposable income being negative or near flat on an annual basis in recent months, a trend typically observed during recessionary periods. Consumers have been relying on savings to maintain spending as energy prices have risen, but Zandi cautioned that this may not be sustainable as personal savings dwindle. The personal saving rate was 3% in May, a decrease of nearly 2 percentage points from the previous year, according to the Bureau of Economic Analysis.

Gasoline prices reached $4 per gallon on Monday for the first time in over a month, according to AAA. Economists anticipate that a resurgence in oil prices will exert upward pressure on the Consumer Price Index (CPI). The 12-month CPI reading in May reached its highest level in three years before easing last month as energy costs moderated. However, the "core" CPI, which excludes volatile food and energy prices, may not follow the same upward trend, potentially preventing the Federal Reserve from needing to raise interest rates. Fed funds futures indicate an over 83% likelihood that the central bank will maintain current rates at its upcoming meeting, according to CME’s FedWatch tool.

Luke Tilley, chief economist at M&T Bank and Wilmington Trust, commented, "We will get some higher inflation readings because of gasoline prices." He added, "The key for the Fed, as all of them have said out loud, is: Is it going to bleed through to core inflation?"

Michael Gunther, an analyst at Consumer Edge, noted that companies with value-focused or driving-dependent consumer bases may see their customer base become more discerning if oil prices remain elevated. This could negatively impact businesses such as Dollar General, Tractor Supply, and Texas Roadhouse. Conversely, warehouse clubs like Costco and Sam’s Club could gain market share as consumers seek value. Costco reported "record-breaking volumes" for gas at the end of its third fiscal quarter, attributing this to higher pump prices driven by the conflict. Gunther observed, "Consumers are paying attention. And they are shifting their habits to manage their wallet."

Retail sales data indicated that consumers continued to spend despite war-related cost increases. However, Gunther pointed to idiosyncratic boosts from events like the World Cup, which may have inflated certain spending categories. Heather Long, chief economist at Navy Federal Credit Union, suggested that consumers had a financial cushion from the larger tax returns under President Donald Trump’s tax legislation when the conflict began. However, she believes they will lack similar support if faced with rising energy prices in the latter half of the year. Long concluded, "The cushion is deflating. There’s no other obvious air pump coming."