Financial markets headed into the new week focused on two interlocking uncertainties: how far the conflict in the Middle East will spread and how much it will push energy prices and inflation higher. The U.S.-Israeli campaign against Iran, now in its seventh day, dominated trading, triggering a notable jump in oil that led to broad asset volatility.
Equities moved sharply in response to the escalation, leaving the S&P 500 down about 2% for the week. Investor unease was visible in the Cboe Volatility Index, which on Friday climbed to its highest reading in nearly a year - a sign markets are pricing in elevated uncertainty.
The selling pressure in stocks was compounded by unexpectedly weak labor-market data released on Friday. U.S. payrolls fell in February, contrary to forecast, while the unemployment rate rose to 4.4%. That combination added another layer of ambiguity for traders trying to reconcile geopolitical risk with domestic economic signals.
Market participants described the situation as unusually unclear. "This is a very big event and it seems incredibly uncertain where it’s headed," said Rick Meckler, partner at Cherry Lane Investments. "To some extent, it’s left investors as neither sellers nor buyers."
Energy tensions and the oil price signal
A central question for markets is how far oil will move as the conflict affects commerce in the Gulf. Fighting has effectively paralyzed shipping through the Strait of Hormuz, an artery that carries roughly a fifth of global oil and liquefied natural gas supplies. Disruption there feeds directly into price formation for crude.
Brent crude rose above $90 a barrel on Friday, a marked increase from about $70 before the weekend strikes. Higher oil costs can depress equity performance in several ways, notably by pushing up gasoline prices and weighing on consumer spending, which in turn can blunt economic growth.
Michael Arone, chief investment strategist at State Street Investment Management, said movements in oil will serve as "a good barometer for whether risk assets will do well or they will do poorly." He added that oil crossing $100 a barrel would be a psychological threshold that "would spook markets more."
Despite the weekly decline, the S&P 500 remained just over 3% below its all-time closing high set in late January, supported to date by expectations of a solid economic backdrop and robust corporate earnings growth.
Dominic Pappalardo, chief multi-asset strategist for Morningstar Wealth, said, "developments in the Middle East will move really all financial markets."
Inflation data adds a wrinkle
Inflation readings are set to take center stage midweek. The U.S. consumer price index for February will be released on Wednesday, following a January report that surprised on the soft side. A Reuters poll cited in market commentary shows economists expect CPI to rise 0.2% month-on-month for February.
Analysts cautioned that any tame print may be discounted by markets because the CPI report largely covers activity before the late-week Middle East escalation. Conversely, a surprise uptick in inflation would pose fresh problems for risk assets.
"If we get upside surprises to the inflation data next week, that could further fuel fears about inflation expectations rising and that would be bad for markets," Arone said. "The concern is that higher oil prices will only feed into higher inflation dynamics going forward."
Implications for interest-rate easing
Rising energy-driven inflation concerns have already altered investor timing for Federal Reserve easing. Although Friday’s weak payrolls figure revived some expectations for rate cuts, market-based probability of at least a 25 basis-point cut at the Fed’s June meeting was around 45% late on Friday, according to LSEG data.
Last year the central bank eased policy to support a weakening labor market, and investors have been factoring in roughly two quarter-point rate reductions this year as part of the bullish case for equities. Higher inflation stemming from rising energy costs would make such easing more difficult to implement.
Pappalardo said, "If we continue to see increasing energy prices sparking inflation concerns, it will be much more difficult for the Fed to implement those two forecast rate cuts in 2026."
Where this leaves investors
For now, participants are balancing the historical tendency of markets to recover after major global shocks against the present lack of clarity over how the Middle East situation will evolve. Oil price trajectories, upcoming CPI data and successive economic releases will likely shape positioning in the near term.
Until there is greater clarity on both the geopolitical front and inflation readings, markets may continue to trade with heightened volatility, as investors weigh the interplay between energy prices, consumer spending and interest-rate expectations.