US equities face rising downside risks as the escalating war in Iran disrupts global markets and fuels inflation concerns, according to veteran market strategist Ed Yardeni.
In his latest outlook, Yardeni increased the probability of a market meltdown this year to 35%, up from 20% previously.
At the same time, he sharply lowered the chances of a market meltup — a rally driven largely by investor enthusiasm rather than fundamentals — to just 5% from 20%.
The reassessment reflects growing uncertainty in financial markets as oil prices surge above $100 a barrel and investors brace for the economic consequences of prolonged geopolitical conflict in the Middle East.
Oil shock complicates economic outlook
The sharp rise in oil prices has become a central concern for markets and policymakers alike.
Higher energy costs risk slowing economic growth while simultaneously pushing inflation higher, a combination that could complicate the Federal Reserve’s policy decisions.
Yardeni warned that the central bank could find itself in a difficult position if the oil shock persists.
“The US economy and stock market are stuck between Iran and a hard place currently. So is the Fed,” Yardeni wrote in a note. “If the oil shock persists, the Fed’s dual mandate would be stuck between the increasing risk of higher inflation and rising unemployment.”
Oil prices have surged amid fears of supply disruptions tied to the ongoing conflict in the Middle East, raising the prospect that inflation pressures could remain elevated for longer than previously expected.
Investors have already begun scaling back expectations for interest-rate cuts by the Federal Reserve.
Markets shift to defensive positioning
Financial markets have started to reflect the heightened uncertainty.
The Bloomberg Dollar Spot Index has climbed nearly 2% since the war began, highlighting a shift toward safe-haven assets.
US equities have so far proved somewhat more resilient than global peers.
The S&P 500 declined about 2% last week, compared with a 3.7% drop in MSCI’s broadest gauge of global equities.
Analysts say that relative resilience partly reflects the United States’ greater energy self-sufficiency compared with regions such as Asia.
However, signs of rising caution among investors are becoming more visible.
S&P 500 futures dropped more than 2% during Asian trading hours on Monday, pointing to further pressure on US stocks.
Hedge funds have also increased short positions in US equity exchange-traded funds.
At the same time, the Cboe VIX Index — a widely watched gauge of market volatility — climbed to its highest level since April’s tariff turmoil.
Bond markets are also reacting to the inflation risk.
Yields on benchmark 10-year US Treasury notes rose six basis points as traders priced in the possibility of higher inflation.
Expectations for Federal Reserve rate cuts have shifted accordingly.
Investors are now pushing back the timing of the next quarter-point reduction to September, compared with earlier expectations for a move in July.
Some bond options traders are even betting that the central bank may not cut rates at all this year.
Long-term outlook remains positive
Despite the near-term risks, Yardeni’s broader outlook for the US economy remains relatively optimistic.
He continues to assign a 60% probability to what he calls the “Roaring 2020s” scenario through the end of the year.
The framework envisions a period of sustained economic growth supported by strong productivity gains.
Looking further ahead, the strategist sees an even higher likelihood that this trend will continue.
Yardeni assigns an 85% probability to a continuation of the Roaring 2020s over the coming decade, while placing a 15% chance on what he describes as a “stagflating 1970s redux.”
However, he cautioned that market sentiment could shift quickly if inflation expectations begin to rise significantly.
“If investors start expecting stagflation, a bear market is more likely,” he wrote.
For now, investors remain focused on how the Iran conflict evolves and whether rising energy prices will translate into sustained economic pressures.
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