Iran war: What’s driving market sentiment?

“It depends on the duration of the conflict.” I cannot remember ever hearing a singular phrase as often as I have this one during the ongoing conflict in Iran. I know that I’ve said it more than once. It has become a kind of shorthand explanation for the uncertainty that conflict brings to economies and markets. If we only knew how long this would last, then we could understand the impact on growth, inflation, policy, and markets.

At the outset, many assumed that anything lasting more than a few weeks would be meaningfully negative for risk assets. Now we’re approaching six weeks. And yet the S&P 500 Index is now nearly flat since the conflict began.¹ Credit spreads have tightened.² Volatility spiked early and then receded.³ Markets did what markets often do — they appear to have absorbed the shock.⁴

That reality forces a reconsideration of the original assumption.

Narratives versus specifics

Perhaps it wasn’t the specific duration that mattered most. Perhaps it was whether the market would ever succumb to a belief that there was no end in sight. Investors, particularly after last year’s Liberation Day whipsaw, have shown little appetite for pricing in open-ended worst-case scenarios.⁵ The cost of being overly defensive too early may remain fresh in investors’ memories.

In that context, markets appear to have made a judgment call. They appear to not have priced this as a conflict that spirals endlessly outward. Even talk of a ceasefire, like we got last week, sustainable or not, had been enough to lift risk sentiment. The bar for relief has been surprisingly low.

The terms of any ceasefire remain unclear. Skeptics have been quick to raise issues around tolls collected by Iran at the Strait of Hormuz or the time required to rebuild damaged energy infrastructure. Initial reports suggest that Iran will demand a toll of $1 for every barrel of oil going through the Strait of Hormuz.⁶ Turning the Strait into a politicized transit route could also raise insurance premiums and financing costs across the energy complex.

These risks are real, but incentives matter. Iran has billions of reasons to normalize energy flows. The region’s Arab producers have strong incentives to rebuild infrastructure quickly and preserve market share. A permanently impaired energy system would hurt everyone involved.

Does that mean we’re heading back to $55 a barrel oil?⁷ Not necessarily. But does it suggest that prices can come down from recent peaks while remaining elevated relative to pre-conflict levels? That seems likely, in my view. Ultimately, the psychological shift from not knowing whether there’s an end to believing that there’s one may be more important than knowing the exact date. Markets appear to crave narrative closure more than calendar precision and tend to trade well if/when conditions are simply getting better relative to the deteriorated expectations.

Macro backdrop remains supportive

Beyond the conflict itself, the broader macro backdrop still offers support. Global leading indicators remained resilient.⁸ Inflation expectations are elevated but contained.⁹ And after a tepid core inflation report,¹⁰ the Federal Reserve may even begin to contemplate rate cuts at some point in the future. This isn’t the pristine Goldilocks environment it felt like at the start of the year, but in my view, it remains one that can sustain risk assets.

Bottom line: Perhaps market implications were never fully dependent on the duration of the conflict. Instead, it may depend on whether investors believed the duration was finite.