Escalating US-Iran Tensions: The Economic Aftershocks Wall Street Can’t Ignore

Amid a fresh escalation in U.S.-Iran hostilities over the weekend, Wall Street is re-evaluating its economic forecasts. While stock markets have largely shrugged off the renewed tensions so far, economists are increasingly concerned that a sustained rise in energy prices could significantly impact consumers and the broader economy.

The U.S. executed its tenth consecutive night of strikes against Iran on Monday, following Yemen's Houthi declaration of a maritime embargo against Saudi Arabia. This intensified military action, which saw a third U.S. service member die, suggests the conflict may be entering a more prolonged and deadly phase. President Donald Trump has vowed strong retaliation, stating, "they will pay."

Despite this, investors have largely maintained composure. The S&P 500 experienced only a marginal dip in Monday's session and remains just 2% shy of its June all-time high. This resilience is partly attributed to the belief that neither the U.S. nor Iran desires an outright war, which would destabilize the global economy.

Wall Street's primary focus has been on strong corporate earnings, which have accelerated since the second-quarter reporting season began, and encouraging softer-than-expected inflation data from last week. However, the recent surge in oil prices and bond yields cannot be overlooked indefinitely.

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

Brent crude briefly soared above $90 a barrel on Monday, hovering near that level into Tuesday. Concurrently, the U.S. 10-year Treasury yield surpassed 4.6%, a critical threshold for traders, and held steady on Tuesday. Should these elevated levels persist, Wall Street may be compelled to recalibrate inflation expectations and monetary policy, ultimately impacting corporate profitability.

Art Hogan, chief market strategist at B. Riley Wealth, emphasized the importance of "duration." He warned that if oil prices remain above $85 or $90 through the end of the year, earnings estimates would likely need trimming, potentially pushing the S&P 500 into a correction. However, he noted that the technology sector, with its 38% weighting in the S&P 500 and relative insulation from higher energy costs, could provide some buffer. Financials and healthcare are also expected to continue benefiting from secular tailwinds. Conversely, the energy sector and logistics companies heavily reliant on fuel, such as Ryanair, which reported delayed bookings due to the Middle East crisis, are most vulnerable.

Geopolitical strategists like BCA Research's Marko Papic are closely monitoring Iran's internal power dynamics and any potential increase in U.S. troop deployment to the region. Yet, some, like JPMorgan's Mislav Matejka, advocate using market dips driven by geopolitical headlines as buying opportunities, viewing such risks as transitory.

Economists, however, paint a more pessimistic picture regarding the domestic impact. Mark Zandi, chief economist at Moody's Analytics, stated that the conflict presents "nothing but downside for the U.S. and global economies," primarily through its effect on oil and commodity prices. He estimates the average American household has already lost around $1,100 from increased energy costs and military expenses, leading to near-flat or negative real disposable income – a trend typically associated with recessions.

Consumers have increasingly relied on savings to maintain spending habits as energy prices climb. This trend is unsustainable, Zandi warns, citing the personal saving rate's drop to 3% in May, nearly two percentage points lower than a year prior. Gasoline prices, for instance, topped $4 per gallon on Monday for the first time in over a month, according to AAA.

While rising oil prices are expected to push the headline Consumer Price Index higher – after May's 12-month CPI reached its highest level in three years before easing – economists like M&T Bank's Luke Tilley believe the Federal Reserve will primarily focus on "core" CPI, which excludes volatile food and energy. A stable core inflation figure could prevent the Fed from needing to hike interest rates further, with Fed funds futures currently pricing an over 83% likelihood of steady rates at the upcoming gathering.

Consumer Edge analyst Michael Gunther highlighted that companies catering to value-conscious or driving-dependent consumer bases, such as Dollar General, Tractor Supply, and Texas Roadhouse, could see clientele become more selective. Conversely, warehouse clubs like Costco and Sam's Club might gain market share as consumers seek better value, with Costco already reporting "record-breaking volumes" for gas during its third fiscal quarter amidst rising pump prices.

Despite resilient retail sales recently, propelled by unique factors like World Cup event tickets and gambling, the cushion that consumers enjoyed from larger tax returns under President Donald Trump's "big, beautiful bill" is now deflating. Heather Long, chief economist at Navy Federal Credit Union, warns there's "no other obvious air pump coming" to alleviate the impact of potentially rising energy prices in the latter half of the year.