Why Wall Street Is Taking the War in Iran in Stride

Key Takeaways

• Stocks rebounded from an early-morning sell-off for a second straight day on Tuesday, underscoring investors’ conviction that the U.S. war in Iran won’t fundamentally change the outlook for a resilient economy.
• A complete closure of the Strait of Hormuz—a remote possibility by most estimates—would be required for oil prices to have a sustained negative effect on U.S. inflation and economic growth, according to some economists.

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With every passing day, the conflict in the Middle East expands to new fronts, but that’s not scaring off investors.

Stocks rebounded on Tuesday from an early morning sell-off, an echo of Monday’s session. The major indexes all fell about 2.5% in the first hour of trading Tuesday, and then slowly and steadily pared their losses to finish the day down less than 1%. (Read Investopedia’s live markets coverage here.) Why have investors been so quick to shrug off escalation and buy the dip?

The worst case scenario for the U.S. stock market in light of events in the Middle East “would be if oil prices were to rise sharply and persistently enough to pose risk to the duration of the business cycle,” wrote Morgan Stanley analysts in a recent note. “However, because we believe we’re in an early cycle environment today with many favorable drivers,” oil would need to be a big drag on the economy to offset its strength.

Why This Is Important

Oil prices are the primary mechanism through which investors expect war in the Middle East will impact the U.S. economy and stock market. Many experts say the economy can weather high prices and volatility if disruptions to global oil supply are short-lived.

Economists at Oxford Economics expressed a similar view. “Except for a severe closure of the Strait of Hormuz, we anticipate the current US goldilocks macro environment to remain largely unaffected by the conflict,” they wrote on Tuesday.

The Strait of Hormuz, which borders Iran and connects the Persian Gulf to the Indian Ocean, is one of the global economy’s biggest vulnerabilities. About a fifth of the world’s oil and liquefied natural gas transits the channel on its way from the petroleum producing states of the Arabian peninsula to importers, primarily in Asia.

Traffic in the strait slowed to a trickle over the weekend after the U.S. and Israel launched strikes against Iran. It was effectively at a standstill on Tuesday after Iran said it was closing the waterway to all ships.  Oil prices rose sharply for the second straight day on Tuesday, though the gains moderated after President Donald Trump said that the U.S. Navy would escort tankers through the straight if necessary.

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Oxford Economics estimates that a “modest disruption” in the strait lasting two months would drive oil prices high enough to add 0.3 to 0.4 percentage points to U.S. inflation. That would surely add to anxiety about the impact that tariffs will have on prices this year. It would also be a reason for the Federal Reserve to leave interest rates unchanged throughout the first half of the year, according to Oxford Economics. “But our modelling suggests this would do little to crimp spending and thus likely fail to derail markets,” according to the firm.

Only a complete shutdown of the strait would raise oil prices enough to change the outlook, according to Oxford Economics. They forecast a complete blockade would push Brent crude, the European benchmark, to $130 a barrel, a full $50 higher than its price in recent trading. On Tuesday, the firm put the likelihood of a complete blockade at just 10% and said the odds are “diminishing over time” as Iran extends the reach of its retaliatory strikes and depletes its firepower.

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