As renewed fighting between the U.S. and Iran raises geopolitical concerns, Wall Street is reevaluating the potential economic fallout. While stocks have largely shrugged off the initial flare-up, economists warn that a sustained rise in energy prices, with Brent crude briefly topping $90, could significantly impact consumer spending and the broader economy, potentially trimming corporate earnings estimates and risking a market correction.
A renewed surge in hostilities between the United States and Iran over the weekend has prompted Wall Street to reassess its projections for the conflict's economic consequences.
The U.S. carried out its tenth consecutive night of strikes against Iran on Monday, following the Houthi declaration of a maritime embargo against Saudi Arabia. This intensification follows the tragic death of a third American service member, signaling a potentially longer and more perilous phase of the war. Former President Donald Trump notably vowed U.S. retaliation, stating on Truth Social that "they will pay."
Despite the escalating tensions, investors largely appear unfazed. The S&P 500 saw only a marginal dip in Monday's trading session after a losing week and remains just 2% shy of its all-time high achieved in June. However, economists are increasingly concerned that steadily climbing energy prices could impose significant burdens on consumers and the broader economy.
'It's about duration'
Thus far, the Middle East conflict has had minimal impact on the stock market. The S&P 500 has rebounded from a late March low to reach record highs, largely on the assumption that neither the U.S. nor Iran desires a full-blown war, an outcome that would severely harm the global economy.
Investors have primarily focused on fundamentals, bolstered by accelerating corporate earnings reports for the second quarter and softer-than-expected inflation data released last week.
Nevertheless, the recent spikes in oil prices and bond yields cannot be ignored indefinitely. Brent crude briefly surpassed $90 a barrel on Monday, maintaining levels just below that mark on Tuesday. Concurrently, the U.S. 10-year Treasury yield traded above 4.6% on Monday, a critical threshold closely monitored by traders, and remained near that level on Tuesday.
Should crude oil and the 10-year Treasury yield continue their ascent—or persist at elevated levels longer than anticipated—Wall Street may be compelled to factor in revised inflation expectations and potential monetary policy shifts that would eventually impact corporate profitability.
"It's about duration," noted Art Hogan, chief market strategist at B. Riley Wealth. "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 the S&P 500 could face a correction in a worst-case scenario. However, he emphasized that the broader index would find support from the technology sector, its largest component, which is relatively insulated from higher energy costs. Tech accounts for 38% of the S&P 500, while energy holds only a 3% weighting, according to S&P Global.
Sectors like financials and healthcare are also expected to benefit from existing secular tailwinds, irrespective of rising oil prices. Conversely, the energy sector and logistics companies heavily reliant on fuel are likely to lag. For instance, Ryanair reported on Monday that its weak first-quarter profits were a reflection of delayed bookings linked to the Middle East crisis.
The region remains under close scrutiny for any escalation that might disrupt passage through the critical Strait of Hormuz.
Marko Papic, a macro and geopolitical strategist at BCA Research, indicated he is monitoring whether Iranian hardliners consolidate power or if the U.S. increases its troop deployment to the Middle East.
Yet, some remain optimistic about the market, anticipating an improved geopolitical outlook in the latter half of the year. JPMorgan's Mislav Matejka maintains his strategy since late March, which involves capitalizing on dips driven by conflict to increase exposure.
"We continue to believe that investors should use the dips driven by geopolitical headlines to add exposure," Matejka wrote earlier this month. "We believe the market has become increasingly adept at pricing geopolitical risk as transitory."
'All downside'
Economists are particularly worried about the implications of a potential resurgence in fuel prices, triggered by the escalating conflict, for U.S. consumers and the businesses serving them.
"There's nothing but downside here for the U.S. and global economies," asserted Mark Zandi, chief economist at Moody's Analytics. "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."
The average American household has reportedly incurred losses of approximately $1,100 from the war thus far, a figure encompassing increased energy costs and higher military expenditures, according to Zandi. This has led to real disposable income being negative or nearly flat year-over-year in recent months, a trend typically observed during recessionary periods.
Zandi noted that consumers have drawn on savings to sustain spending amidst rising energy prices. However, he cautioned that this strategy may be unsustainable as emergency funds dwindle: the personal saving rate stood at 3% in May, nearly two percentage points lower than the previous year, as per the Bureau of Economic Analysis.
Gasoline prices climbed to $4 per gallon on Monday for the first time in over a month, according to AAA.
Economists predict that a rebound in oil prices will exert upward pressure on the consumer price index (CPI). May's 12-month CPI reading reached its highest level in three years before receding last month as energy costs eased.
Nevertheless, the "core" CPI reading, which excludes volatile food and energy prices, may not follow suit, potentially alleviating pressure on the Federal Reserve to raise interest rates. Fed funds futures indicate an over 83% probability that the central bank will keep rates steady at its upcoming meeting, according to CME's FedWatch tool.
"We will get some higher inflation readings because of gasoline prices," stated Luke Tilley, chief economist at M&T Bank and Wilmington Trust. But, "the key for the Fed, as all of them have said out loud, is: Is it going to bleed through to core inflation?"
Companies catering to value-conscious or driving-dependent consumer bases might see their clientele become more selective if oil prices remain elevated, according to Consumer Edge analyst Michael Gunther. This trend could negatively impact businesses ranging from Dollar General to Tractor Supply to Texas Roadhouse, his firm found.
Conversely, Gunther suggested that warehouse clubs such as Costco and Sam's Club could gain market share as consumers prioritize value. Costco notably reported "record-breaking volumes" for gasoline sales at the close of its third fiscal quarter when the war first drove pump prices higher.
"Consumers are paying attention," Gunther observed. "And they are shifting their habits to manage their wallet."
Retail sales figures showed continued consumer spending despite war-related cost shocks. However, Gunther attributed this partly to unique boosts, such as increased spending on event tickets and gambling during the World Cup.
Consumers also benefited from a cushion when the war erupted, thanks to larger tax returns under former President Donald Trump's "big, beautiful bill," according to Heather Long, chief economist at Navy Federal Credit Union. But Long cautioned that similar tailwinds are unlikely to materialize if consumers face rising energy prices in the latter half of the year.
"The cushion is deflating," Long warned. "There's no other obvious air pump coming."
Courtesy: U.S. Navy
