It’s now been a month since the most recent outbreak of hostilities in the Middle East involving the United States, Israel, and Iran. Despite the magnitude of the conflict, global capital markets held up relatively well in the early stages. More recently, volatility has increased as expectations for a quick resolution have faded, and the risk of a more prolonged conflict has grown.
Given these developments, it’s helpful to examine the situation across several dimensions that matter most for markets, the economy, and investor portfolios.
Geopolitical
The immediate geopolitical impact has been destabilizing — an unsurprising outcome given the scale and global implications of the conflict. Of course, the stated goal of significantly degrading Iran’s nuclear capabilities, if achieved, would reduce a potentially significant source of long‑term regional instability. Indications are that the campaign has been successful in setting those capabilities back, though ultimate success will be measured by how far the program has been hindered and whether Iran’s ability to rebuild those capabilities can be effectively constrained.
Hopes for a relatively brief conflict remain high but have diminished by the apparent intransigence of Iran’s leadership toward negotiations and the seeming lack of tangible progress toward a ceasefire. Iran’s attempts to draw others into the conflict have been largely unsuccessful to this point, despite their successful targeting of energy and other infrastructure across multiple neighboring states. Given the long-standing friction between Iran and other countries across the Gulf region, it’s no surprise that regional support for reducing Iran’s capability to project power hasn’t publicly wavered.
What’s been more notable is the strain on transatlantic relations. Support from America’s European allies has been tepid, leaving the United States to shoulder most of the burden while navigating an increasingly complex geopolitical landscape.
Bottom line: The conflict adds another layer of complexity to an already-fragile global geopolitical environment that’s become increasingly tenuous in recent years.
Crude oil and energy prices
If there’s one area where volatility has been most evident, it’s energy. At recent highs, Brent crude had nearly doubled since the beginning of the year. A coordinated release from global strategic reserves and periodic indications that the conflict could be short-lived provided temporary relief, but prices have since moved back above $100 per barrel.
The closure of the Strait of Hormuz — a risk we highlighted earlier this month — remains the key factor supporting elevated prices. Hopes for a breakthrough in back‑channel negotiations briefly eased market concerns, but those hopes faded quickly following Iran’s rejection of U.S. proposals and signs that a further escalation could be imminent.
The United States is better positioned than much of the world as the largest oil producer and a net exporter of petroleum products. Still, higher global prices are being felt by U.S. consumers and businesses alike. Absent a meaningful de‑escalation in tensions, elevated oil and gasoline prices are likely to persist.
Bottom line: Keep an eye on the logjam in the Persian Gulf. Until energy flows normalize, a larger geopolitical risk premium will remain embedded in prices.
Inflation
Inflation was already elevated and somewhat sticky prior to the conflict, and the spike in energy prices will push near‑term inflation higher. While comparisons to the 1970s oil shock may come to mind, they’re less relevant today given the U.S. economy’s shift toward services and information technology, improved energy efficiency, and significantly higher domestic production.
A commonly referenced rule of thumb is that a $10 increase in oil prices lifts CPI by roughly 0.2–0.4%, though duration matters. A short‑lived disruption would produce a temporary inflation bump, while a prolonged conflict would create more persistent pressures as higher costs ripple through the economy.
A near‑term rise in headline inflation into the 3–4% range appears likely, but the potential for a rapid reversal remains if tensions ease.
Bottom line: Inflation is set to rise in the near term, but it may not become entrenched if a diplomatic solution emerges.
The economy
Consumers are already feeling the impact at the gas pump, which will constrain discretionary spending for many households. Businesses across the transportation, airlines, agriculture, chemicals, tourism, and retail sectors are also facing higher input costs.
These pressures leave companies with a familiar dilemma: absorb higher costs through lower margins or pass them along to customers. The longer energy prices stay elevated, the more likely those costs are to be passed through.
The economy slowed late last year but was expected to rebound this quarter, supported in part by increased government spending. That rebound may still come, but higher energy costs will in time meaningfully erode household spending power, a risk that could become apparent in March retail results and even more evident in Q2 GDP if energy costs remain elevated for an extended period.
Bottom line: Elevated energy prices will weigh on consumption and profitability across multiple sectors in the near term.
Federal Reserve policy
Higher energy prices matter for the Fed, but they’re unlikely to drive near‑term policy decisions. As reiterated at its March meeting, the Fed still sees steady economic growth and relatively tight labor markets, even as job creation has been uneven.
Policymakers are acutely aware of the uncertainty surrounding the conflict. Just as quickly as oil prices rose, they could fall if tensions ease. That, in part, is why the Fed focuses more intently on core inflation, which excludes food and energy, in assessing the inflation outlook. Historically, the Fed has preferred a measured approach during periods of geopolitical stress, balancing its dual mandate of price stability and maximum employment.
Aggressively raising rates in response to energy‑driven inflation could further weaken job growth, while cutting rates risks exacerbating inflation pressures. The Fed will need to operate with a steady hand to navigate a policy path on which both sides of its mandate are subject to risk.
Bottom line: The Fed remains in a wait‑and‑see mode. Absent a more significant economic shock, policy rates are likely to remain unchanged for now.
Capital markets
U.S. equities held up relatively well through the early stages of the conflict, though day‑to‑day volatility has increased. Markets have become highly sensitive to headlines, with sharp swings driven by shifting expectations around potential progress in negotiations and the risk of escalation.
Treasurys have outperformed equities but haven’t benefited from a classic flight‑to‑safety rally. Instead, rising inflation expectations have pushed the 10‑year Treasury yield higher, restraining near‑term fixed income returns. As inflation concerns eventually ease, falling rates would provide a tailwind for bonds.
Most forecasts from geopolitical analysts still suggest that pressure will build for a negotiated off‑ramp over time. Any credible progress toward de‑escalation would be welcomed by markets. Until then, investors should expect continued volatility.
Bottom line: Volatility cuts both ways. Investors should remain strategic and avoid trading based on rapidly changing headlines.
Final thoughts
Periods of geopolitical stress test investor patience and market sentiment. With another conflict now creating uncertainty for the markets, a few principles are worth emphasizing:
- Geopolitical shocks are often episodic. Their market impact is frequently shorter‑lived than initially feared.
- Energy price volatility doesn’t automatically derail expansions. Improved efficiency and diversified supply matter, as does the position of the U.S. as a net exporter that’s less dependent upon foreign-sourced oil.
- Diversification continues to work. Dispersion across assets, sectors, and regions has helped portfolios navigate recent volatility.
- Emotional reactions can be costly. Markets often price worst‑case scenarios quickly, then recover as outcomes prove less severe.
While the current environment may contribute to near‑term volatility and inflation noise, it doesn’t undermine the case for disciplined, long‑term investing. Staying focused on fundamentals, maintaining diversification, and preserving liquidity remain the most reliable strategies in an uncertain world. We’ll continue to monitor developments and evaluate what steps, if any, may be appropriate.
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Plante Moran Financial Advisors (PMFA) publishes this update to convey general information about market conditions and not for the purpose of providing investment advice. Investment in any of the companies or sectors mentioned herein may not be appropriate for you. You should consult a representative from PMFA for investment advice regarding your own situation.
