The Stock Market Is Shrugging Off the Israel-Iran Conflict. Is That Normal?

Stocks rose and oil prices retreated on Monday as investors shrugged off the continuation of hostilities between Israel and Iran over the weekend. 

The S&P 500 was up nearly 1% in midday trading Monday, while the Nasdaq Composite rose 1.4%, and the Dow Jones Industrial Average was up just under 1%. 

Friday was a rough day on Wall Street—oil prices surged, causing stocks to slide, the Cboe Volatility Index (VIX) to jump, and gold to rise as investors moved into safe havens. But there was plenty of evidence that investors weren’t that concerned about the conflict spiraling out of control. High yield credit spreads increased just 2 basis points, a sign of modest risk aversion, and the MSCI World Index closed just 1% off its all-time high. 

It’s not out of the ordinary for markets to quickly shrug off major geopolitical events. The S&P 500 tends to fall about 6% in the three weeks after a geopolitical shock before recovering all of those losses in the following three weeks, according to a recent survey by Deutsche Bank analysts Parag Thatte and Binky Chadha. And with equity positioning historically low by their measure, a bigger sell-off is even more unlikely today. 

Geopolitics has had a sustained impact on the stock market only when it’s affected the real economy, whether by slowing growth or lifting inflation, Deutsche Bank analyst Henry Allen said in a note on Monday. There are only a few examples of oil shocks having a meaningful impact on stocks, including the oil embargo of the 1970s and Iraq’s invasion of Kuwait in 1990. 

Last Geopolitical Impact on Stocks Was Ukraine Invasion

The most recent example of a geopolitical disruption to the stock market is Russia’s invasion of Ukraine in 2022, which bears some troubling resemblance to today. Inflation was already running above target when Russia’s invasion drove oil prices up more than 30% in a matter of weeks. The oil- supply shock fueled an acceleration of already-elevated inflation, likely forcing central banks to raise interest rates faster and higher than they would have otherwise, Allen’s report said. 

Inflation has moderated considerably since hitting a 40-year high in June 2022. Consumer prices increased 2.4% year-over-year in May, just slightly above the Federal Reserve’s 2% target. However, President Donald Trump’s tariffs threaten to raise prices, and their inflationary impact could be exacerbated by escalation in the Middle East. 

“The inflation risk really matters, because the problem with higher inflation is it will restrict central banks from cutting rates, as is currently priced,” Allen wrote. The majority of investors are currently pricing in rate cuts of at least 100 basis points by the end of next year. Resurgent or sticky inflation would leave the Fed little room to cut interest rates if tariffs and high oil prices weighed on growth or the labor market.