Oil shocks, Fed risks, and market resilience

Key Takeaways:

• The Iran conflict has triggered a meaningful oil shock and the duration of the disruption will determine the economic and market impact.
• This does not appear to be a repeat of the 1970s. Energy is a smaller share of consumer spending, the U.S. is more insulated on supply, and the economy is less oil-intensive.
• Our base case is a sharp but temporary rise in oil prices. In that scenario, growth slows modestly, inflation rises near term, and the Fed cuts once later this year.
• The Fed is likely to remain cautious for now. Policymakers appear willing to look through a one-time energy-driven inflation boost, though inflation expectations will be key.
• Volatility may remain elevated, but stronger fundamentals should provide some cushion. If oil stays high, energy, U.S. large caps, and tech may hold up best; if tensions ease, small caps, value, and international stocks could lead. 

Markets remain on edge as the Iran conflict enters its fourth week, with stocks moving in the opposite direction of the sharp swings in oil prices. Recent attacks on Middle East energy infrastructure triggered the first 5% pullback in the S&P 500 this year, underscoring investor sensitivity to escalating geopolitical risks. Brent crude, the European benchmark for global oil pricing, briefly retested its $120 highs, while WTI, the U.S. benchmark, climbed toward $100.

Amid the largest disruption to global oil markets on record, central banks now face a policy dilemma: respond to the upside risks to inflation or the downside risks to the labor market? While the ultimate trajectory of the conflict remains uncertain, we offer the following perspective on the potential economic, Fed, and market implications.

Headwinds are mounting 

Much will depend on the duration of the conflict and the persistence of the disruption to energy markets. If the rise in oil prices proves sustained, or accelerates further, downside risks to the economy would increase. Higher energy prices effectively act as a tax on consumers, eroding purchasing power and weighing on discretionary spending. Every additional dollar spent at the pump is a dollar not spent elsewhere.

With consumer spending accounting for nearly 70% of U.S. economic activity, a prolonged energy-driven squeeze would likely slow growth. That said, any moderation would be occurring against a backdrop of an economy that had entered this period on relatively solid footing, in our view. On the inflation front, higher energy prices would lift headline inflation and further complicate the outlook for central banks.

Why this is not a 1970s-style energy crisis 

While the Iran conflict has created a major oil shock, today’s backdrop is fundamentally different from the one that produced the stagflation of the 1970s for several reasons.

• Energy is a smaller drag on consumers than it used to be — Energy spending as a share of total consumer spending is materially lower than it was during the 1970s and early 1980s (roughly 2% today versus about 6% then), suggesting that the direct hit to household purchasing power from a given oil shock is smaller today.
• The U.S. is far more insulated on the supply side — The U.S. has been a net exporter of oil since 2019, and domestic natural-gas prices have remained relatively insulated from the disruption, even as Europe and Asia face a supply crunch. U.S. shale producers stand to benefit from higher prices, even if that support does not fully offset the drag from weaker consumer spending.
• Oil still matters, but less in a services-based economy — Large oil-price moves still hurt, but the global economy is simply less oil-intensive than it was during the original energy crises. Since 1950, the amount of energy required to produce one unit of GDP has fallen by roughly 70%, reflecting efficiency gains and the growing importance of the services sector.

Three scenarios to frame uncertainty 

Given the high degree of uncertainty and the close relationship between energy, the economy, and markets, we outline three scenarios based on both the level and persistence of oil prices.

1. Sharp, but short-lived spike (60% probability) : In our baseline scenario, we assume WTI oil prices trade in a range of roughly $90–$100 before moderating to $70–$80 by year-end. Energy flows through the Strait of Hormuz remain constrained through at least part of the second quarter but begin to gradually normalize thereafter. In this scenario, headline inflation likely rises above 3% before easing later in 2026, while growth slows modestly to below trend. The Fed delivers one rate cut late in the year, Treasury yields remain rangebound, and U.S. equities outperform in the near term.
2. Oil shock (30% probability): In our downside scenario, oil prices spike to $120 or higher and remain elevated for several months as the conflict persists and damage to energy infrastructure disrupts supply. Under this outcome, inflation accelerates toward 4% and remains elevated through 2026 before cooling more sharply in 2027. Growth slows more materially, unemployment rises, but the economy avoids recession. The Fed remains on hold this year but delivers multiple rate cuts in 2027 in response to growing growth risks. Bond yields initially move higher before falling sharply, and the S&P 500 experiences a correction of roughly 10% to 15%.
3. Quick de-escalation (10% probability): Our best-case scenario assumes oil prices fall rapidly in the coming weeks toward $70 as the conflict de-escalates and energy flows normalize. In this case, there is a temporary bump in inflation in the March and April data, followed by a quick return to disinflation, allowing the Fed to cut rates twice in the second half of the year. Bond yields decline, equities rally, and more cyclical areas of the market, including small caps and international stocks, outperform.

Fed on hold as it performs a balancing act 

Amid the current energy crunch, the Fed must balance downside risks to the labor market against upside risks to inflation. Historically, central banks have tended to look through temporary spikes in oil prices. However, with inflation running above the Fed’s target for the past five years, the latest surge in energy costs makes it increasingly difficult for policymakers to dismiss the risks. Here is what we learned from last week’s Fed meeting:

• The Fed left rates unchanged in March at 3.5%–3.75%, as expected, with Chair Powell emphasizing the uncertainty surrounding developments in the Middle East.
• The Fed’s projections continued to show one additional rate cut in 2026 and one in 2027, although fewer participants now expect two or more cuts. Markets moved even further in that direction, with bond investors pricing out cuts this year.
• Notably, estimates for economic growth were revised higher over the next several years and in the long run, with Powell pointing to stronger productivity in the U.S.
• The Fed revised up its inflation estimate for this year to 2.7% but left the next two years largely unchanged. Outside of the expected increase in energy prices, policymakers still expect the effects of tariffs to fade and housing disinflation to continue.
• Powell said he would continue to lead the Fed beyond his scheduled term expiration if Kevin Warsh, President Trump’s nominee to replace him, has not yet been confirmed by the Senate.

The key takeaway is that the Fed avoided any major shifts as it is still too early to determine how the conflict will affect either side of its mandate. By keeping one rate cut in its forecast, the Fed perhaps appears willing to look through a one-time boost to inflation. Unlike in 2022, when energy prices surged after Russia’s invasion of Ukraine, the labor market is no longer tight, policy is no longer easy, and fiscal stimulus is modest.

Inflation expectations will be a key variable to watch in the months ahead. So far, the rise appears concentrated in short-term measures, while longer-term expectations remain well anchored. If the conflict proves short-lived, we think the downtrend in inflation should resume, allowing the Fed to deliver one cut in the second half of the year.

Abroad, the calculus may differ. Central banks that are already closer to neutral and focused primarily on inflation, rather than the Fed’s dual mandate, may be less willing to look through an energy-driven inflation shock. Still, they are likely to remain in wait-and-see mode for now.

Solid fundamentals provide a cushion, but volatility may stay elevated 

While there is no recent precedent for the scale of this energy disruption, U.S. oil prices have reached, and in some cases exceeded, current levels several times over the past 15 years without tipping the economy into recession. During the 2011–2013 period of geopolitical instability associated with the Arab Spring, oil prices often remained above $100 per barrel. Similarly, Russia’s invasion of Ukraine triggered a sharp, though ultimately brief, spike in commodity prices.

Oil prices today are trading at comparable levels, but the underlying fundamentals are stronger, in our view. Prices would likely need to remain above current levels for a sustained period to match the economic drag associated with those earlier episodes. Consumers’ disposable income has nearly doubled since 2011, household debt relative to income remains low, and unemployment is still low by historical standards. At the same time, the ongoing AI investment boom and continued innovation are providing an additional source of support for growth. The bottom line is that the conflict is likely to be growth-negative and inflation-positive, but overall economic resilience should hold, with the duration of the conflict remaining the key variable.

From a portfolio perspective, as long as oil prices remain elevated, the energy sector, U.S. large caps, and technology may offer relative defensiveness. By contrast, if the disruptions prove short-lived, small caps, value, and international equities could be positioned to outperform. Bonds typically struggle when inflation concerns intensify, but in our baseline scenario, we expect the 10-year Treasury yield to remain within its recent range. We would be more inclined to consider extending duration if the 10-year yield moves toward 4.5%.

Investing through periods of uncertainty is never comfortable, but long-term investors can use bouts of volatility to rebalance portfolios, strengthen diversification, and add high-quality investments at more attractive valuations.

Angelo Kourkafas, CFA
Senior Global Investment Strategist

_{Source for all data: FactSet, Bloomberg, Edward Jones} 

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^{Source: FactSet, March 20, 2026. Bonds represented by the iShares Core U.S. Aggregate Bond ETF. Past performance does not guarantee future results. *Morningstar Direct, March 22, 2026.}

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