Seven Questions Answered on the U.S.–Iran Conflict
Photo Credit: Messrro, Unsplash
Key Takeaways
What Happened
The U.S. and Israel struck Iran on February 28, triggering retaliation and closure of the Strait of Hormuz. Oil surged 12% over five days, with new tariffs adding further inflation pressure.
Initial Impacts
U.S. equities are largely unchanged, as investors view the shock as likely short-lived. Bonds are behaving unusually. Treasury yields have risen rather than fallen, as inflation concerns offset the flight-to-safety dynamic and reduce diversification benefits.
What to Watch
The key variable is how long the Strait of Hormuz remains closed, as an extended disruption would translate into higher gasoline and living costs. We are monitoring high-yield credit spreads for signs of economic stress and diplomatic developments for signs of an early resolution. For now, diversified portfolios have seen limited damage.
1. What happened, and why are markets reacting this way?
On February 28, the United States and Israel launched coordinated military strikes against Iran. Iran responded with retaliatory missile and drone attacks against Israel, U.S. military bases, and civilian energy infrastructure across the Persian Gulf. The conflict is now in its fifth day.
The most significant market consequence has occurred in energy markets. Iran’s military declared the Strait of Hormuz (the narrow waterway through which roughly 20% of the world’s oil supply passes) closed to commercial shipping. Major marine insurers have withdrawn coverage for vessels in the Persian Gulf, effectively halting tanker traffic regardless of whether a physical blockade exists. WTI crude oil has surged approximately 12% over the past five days.
Despite the severity of the conflict, U.S. equity markets have been remarkably measured. The S&P 500 traded lower on Tuesday as the conflict widened, but it has rebounded as of Wednesday. Over the three trading sessions since fighting began, the S&P 500 is roughly flat. The VIX rose above 28 on Tuesday before settling back below 21 on Wednesday, elevated but well below the levels (30 and above) typically associated with genuine market crises.
2. Why Have Stocks Not Fallen More Given the Severity of the Conflict?
Two factors help explain the equity market’s relative composure.
First, history. Geopolitical shocks have generally been short-lived for stock markets. Investors have learned (correctly, on average) that selling into an initial geopolitical scare tends to be a losing strategy, and markets often recover within the following weeks. That historical pattern is clearly influencing behavior here.
Second, there are early signs of a potential diplomatic off-ramp. On Wednesday, there are reports that Iranian intelligence operatives have indirectly contacted the CIA through a third country’s spy service to discuss terms for ending the conflict. While President Trump publicly dismissed the overture, and the report’s sourcing is thin, the market appears to be assigning some probability to a near-term resolution. Wednesday’s equity bounce and modest oil pullback coincided with that report.
Critically, corporate bond markets are confirming the equity market’s relative calm. High-yield credit spreads are essentially unchanged from pre-conflict levels. When corporate bond investors are not demanding meaningfully higher compensation for risk, it signals that the market does not see an imminent threat to the broader economy or corporate health. That is the single strongest data point arguing against panic at this stage.
The important caveat: the market’s composure is built partly on the assumption that this conflict will be resolved relatively quickly. If the diplomatic signal fades and the Strait of Hormuz remains closed for weeks rather than days, equity markets may need to reprice.
3. Why Are Bonds Not Providing Their Usual Safety Cushion?
This is one of the most unusual aspects of the current environment, and it’s worth discussing separately. In a typical geopolitical crisis, Treasury bonds rally as investors seek safety. Yields fall, bond prices rise, and balanced portfolios benefit from the offset. That is not what is happening here.
The 10-year Treasury yield has risen roughly 10 basis points since the conflict began, moving from 3.96% to 4.10%. The 2-year yield, which is more sensitive to near-term Federal Reserve policy expectations, has risen slightly more, up roughly 14 basis points to 3.53%.
The reason is straightforward: the bond market is more worried about inflation than about economic weakness. A sustained spike in oil prices feeds directly into consumer prices at the gas pump and in transportation costs, and eventually into a wide range of goods and services. Several Federal Reserve officials have already signaled that rate cuts are now less likely given this inflationary risk. When the bond market prices in higher inflation and fewer rate cuts, yields rise rather than fall even during a geopolitical crisis.
For balanced portfolio investors, this means the traditional diversification benefit (bonds cushioning equity losses) has been partially muted during this event. It does not mean diversification is broken, but it does mean that in an inflation-driven geopolitical shock, the cushion is thinner than investors may expect.
4. Will This Affect Gas Prices And The Cost Of Living?
If the Strait of Hormuz remains effectively closed for an extended period, the answer is very likely yes. The Strait handles roughly one-fifth of the world’s oil supply and a similar share of global liquefied natural gas. The disruption is already reflected in energy markets. European natural gas futures surged over +50% in the first two sessions, and diesel futures spiked as well.
The transmission of consumer prices depends heavily on how long the disruption lasts. A brief spike that resolves within a week or two may produce a temporary increase at the gas pump but is unlikely to meaningfully change the inflation outlook. A multi-week or longer closure would be a different story.
Adding to the inflation picture, Treasury Secretary Bessent confirmed this week that a 15% global tariff will be implemented imminently. Tariffs raise the cost of imported goods independently of energy prices. The combination of an energy supply shock and broad-based tariffs creates two separate upward pressures on consumer prices arriving at the same time. This dual dynamic is part of why the Federal Reserve has signaled greater caution on rate cuts.
For context, the U.S. is a major oil producer and is less exposed to a Strait of Hormuz closure than many other countries. However, oil is priced on a global market, so a disruption of this magnitude affects prices everywhere, regardless of where a country sources its supply.
5. How Are International Markets Being Affected Differently?
International equities have taken a significantly harder hit than U.S. markets. International stocks underperformed U.S. stocks on Tuesday. South Korea’s stock market, which was closed for a holiday when the conflict began, fell roughly 7% when it reopened Tuesday, and the selling pressure extended into Wednesday with a decline of more than 10%.
The disparity makes sense given the nature of the event. The energy supply disruption disproportionately affects countries that import most of their oil and natural gas. Much of Europe, Japan, and South Korea rely heavily on energy that transits through or near the Persian Gulf. In contrast, the United States, as a large domestic energy producer, is relatively more insulated.
A strengthening U.S. dollar adds to the pressure on international investments when measured in dollar terms. For investors with international diversification in their portfolios, this specific event has produced a larger drawdown in those holdings than in U.S. equities. Over longer periods, geographic diversification remains sound, but in the near term, the nature of this particular shock favors the U.S. relative to the rest of the world, as the strengthening dollar can lead to reduced returns on foreign investments when converted back to dollars.
6. What Are We Watching To Determine If This Gets Worse?
Three indicators will tell us whether this remains a contained event or evolves into something more consequential for portfolios: First, credit spreads. As noted above, high-yield corporate bond spreads have been stable throughout the conflict so far. If spreads begin to widen meaningfully, it would signal that the market is pricing in real economic damage, not just temporary uncertainty. This is the single most important indicator we are monitoring.
Second, the duration of the Strait of Hormuz closure. The market is clearly betting on a short-lived disruption. Every additional week the strait remains closed to commercial shipping increases the probability that the oil price shock becomes embedded in inflation expectations, forces the Federal Reserve to delay or cancel rate cuts, and begins to weigh on corporate earnings and consumer spending. Time is the variable that converts a contained shock into a broader economic headwind.
Third, the diplomatic track. The reported back-channel contact between Iranian intelligence and the CIA is fragile and unconfirmed, but it is the first concrete signal of a potential off-ramp. Whether that channel produces results (or collapses) will significantly influence how markets behave in the coming days. Iran’s leadership succession remains unresolved, which complicates any diplomatic process, and the administration’s public rhetoric has remained escalatory even as the back-channel report emerged.
7. What Does This Mean For Your Portfolio Right Now?
Through five days of a serious geopolitical conflict, the direct impact on diversified U.S. portfolios has been limited. U.S. equities are roughly flat. Credit markets are stable. The VIX, or Volatility Index, is elevated but contained, indicating that market volatility is higher than usual but not excessively so. These are not the conditions that warrant reactive changes to a well-constructed portfolio.
The development that deserves the most attention is the bond market’s behavior. Because the dominant concern is inflation rather than economic contraction, Treasuries have not provided their usual offset to equity risk. This doesn’t mean bonds aren’t doing their job, but the specific nature of this event (an energy supply shock that raises inflation) has temporarily muted the diversification benefit that investors are accustomed to.
History supports patience. Geopolitical shocks, even severe ones, have overwhelmingly been resolved without lasting damage to equity markets. The current data supports that base case: credit is calm, volatility is moderate, and there are early (if fragile) signs of diplomatic engagement.
That said, if the Strait of Hormuz remains closed for an extended period, the economic and market consequences could grow. We are monitoring this closely and will communicate promptly if conditions change in a way that warrants a reassessment.
Important Disclosures
This material is provided for general and educational purposes only and is not investment advice. Your investments should correspond to your financial needs, goals, and risk tolerance. Please consult an investment professional before making any investment or financial decisions or purchasing any financial, securities, or investment-related service or product, including any investment product or service described in these materials.
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