As tensions escalate between Israel and Iran, financial markets are on edge, with investors bracing for a potential “knee-jerk” selloff if the United States becomes directly involved in the conflict. Economists warn that a dramatic rise in oil prices could further strain a global economy already grappling with the adverse effects of President Donald Trump’s tariffs. With major U.S. stock indexes trading near record highs despite ongoing geopolitical and trade uncertainties, equities may be particularly vulnerable to additional sources of volatility.
On June 18, Reuters reported that oil prices fell nearly 2% as investors weighed the likelihood of supply disruptions from the conflict and the possibility of direct U.S. military involvement. Despite this dip, crude prices remain up almost 9% since Israel launched attacks against Iran last Friday in an effort to cripple its nuclear weapons program. The uncertainty surrounding U.S. intervention has sparked fears among investors about the potential for wider regional instability, threatening critical energy resources, supply chains, and infrastructure.
Immediate Market Reaction to Escalating Tensions
Chuck Carlson, CEO of Horizon Investment Services, noted that U.S. stocks might initially sell off should President Trump order the U.S. military to take a more active role in the Israel-Iran conflict. However, he added that a faster escalation could also bring the situation to a quicker resolution.
“I could see the initial knee-jerk reaction would be, ‘this is bad,'” Carlson said. “But I think it will bring things to a head quicker.”
This sentiment reflects a broader expectation among analysts that while markets may experience short-term turbulence, the ultimate impact will depend on the scale and duration of any U.S. involvement. On Wednesday, the S&P 500 (.SPX) edged up modestly by 0.3%, even as Treasury yields fell amid heightened demand for safe-haven assets like U.S. debt.
The dollar, another traditional safe haven, has gained around 1% against both the Japanese yen and Swiss franc since last Thursday. However, on Wednesday, the greenback took a breather, edging fractionally lower against these currencies.
Oil Prices and Economic Risks
The prospect of reduced Iranian oil exports has sent shockwaves through energy markets. Barclays warned that crude prices could rise to $85 per barrel if Iranian exports are cut by half. In a worst-case scenario involving a broader conflagration, prices could surge to $100 per barrel. Brent crude was last trading at approximately $76.
Such price spikes would pose significant challenges for the global economy. Citigroup economists highlighted in a note that materially higher oil prices would act as a negative supply shock, lowering growth and boosting inflation. This comes at a time when central banks are already navigating the economic risks posed by Trump’s tariffs.
The World Bank recently slashed its global growth forecast for 2025 by four-tenths of a percentage point to 2.3%, citing higher tariffs and increased uncertainty as “significant headwinds” for nearly all economies. A prolonged spike in oil prices could exacerbate these pressures, further complicating efforts to stabilize global markets.
Defense Stocks Rally Amid Geopolitical Uncertainty
While broader markets have shown signs of caution, defense stocks have benefited from the rising geopolitical tensions. The S&P 500 Aerospace and Defense index (.SPLRCAED) hit record highs last week, capping a rebound of over 30% following losses incurred after Trump’s April 2 “Liberation Day” tariff announcements.
Trades on the Polymarket betting website point to a 63% expectation of “U.S. military action against Iran before July”, down from as much as an 82% likelihood on Tuesday, but still above a 35% chance before the conflict began last Friday.
Similarly, the S&P 500 energy sector index (.SPNY) has rallied over 2% in the past four sessions, driven by gains in companies like Exxon Mobil (up 3.8%) and Valero Energy (up 5%). By contrast, the broader S&P 500 declined 0.7% during the same period, underscoring investor concerns about the economic implications of higher oil prices and growing global uncertainty.
Speculation on U.S. Military Action
The U.S. military is bolstering its presence in the region, according to Reuters, fueling speculation about potential U.S. intervention. Investors fear such action could widen the conflict in an area rich with critical energy resources, supply chains, and infrastructure.
Peter Cardillo, Chief Market Economist at Spartan Capital Securities, expressed skepticism about the U.S. joining the war but warned of potential market impacts if it does.
“I don’t think personally that we are going to join this war. I think Trump is going to do everything possible to avoid it. But if it can’t be avoided, then initially that’s going to be negative for the markets,” Cardillo said. “Gold would shoot up. Yields would probably come down lower, and the dollar would probably rally.”
Barclays warned that crude prices could rise to $85 per barrel if Iranian exports are reduced by half. In a worst-case scenario involving wider conflict, prices could surge to $100 per barrel. Brent crude currently sits at around $76.
Citigroup economists cautioned in a note that materially higher oil prices would act as a negative supply shock for the global economy, lowering growth and boosting inflation. This would create further challenges for central banks already navigating risks posed by Trump’s tariffs.
Investor Sentiment and Market Resilience
Even amid the latest geopolitical uncertainty, the S&P 500 remains just 2% below its February record high close. Many investors appear willing to overlook current tensions unless there is clear evidence of a larger regional conflict or significant U.S. involvement.
Osman Ali , Global Co-Head of Quantitative Investment Strategies, addressed this sentiment at an investor conference on Wednesday:
“Investors want to be able to look past this, and until we see reasons to believe that this is going to be a much larger regional conflict with the U.S. perhaps getting involved and a high chance of escalating, you’re going to see the market shrug this off as much as it can.”
This resilience reflects a broader belief that the market can absorb short-term shocks without derailing long-term trends. However, the combination of geopolitical tensions and existing economic headwinds—such as Trump’s tariffs—creates a precarious environment where any miscalculation could trigger widespread volatility.
Broader Implications for Global Markets
The potential for U.S. involvement in the Israel-Iran conflict underscores the interconnectedness of geopolitics and financial markets. A sharp rise in oil prices, coupled with supply chain disruptions, could have far-reaching consequences for industries ranging from transportation to manufacturing. Meanwhile, the flight to safety could drive further demand for U.S. Treasuries and the dollar, potentially widening interest rate differentials and impacting currency markets.
Iranian Supreme Leader Ayatollah Ali Khamenei’s rejection of Trump’s demand for unconditional surrender adds another layer of complexity to the situation. With no clear path to de-escalation, the risk of unintended consequences looms large.
Final Thoughts
The possibility of U.S. military involvement in the Israel-Iran conflict poses a significant threat to financial markets, with the potential for a swift and severe selloff should tensions escalate. While some analysts believe that a rapid resolution could mitigate long-term damage, others warn that the global economy is ill-prepared for the combined pressures of higher oil prices, tariffs, and geopolitical instability.
For now, investors remain cautiously optimistic, focusing on the absence of concrete evidence pointing to a larger regional conflict. However, the situation remains fluid, and any unexpected developments could quickly shift market sentiment. As always, staying informed and maintaining a diversified portfolio are key strategies for navigating uncertain times.
⏩ Stay tuned for updates on how the Israel-Iran conflict unfolds and its implications for global markets.
