Iran's diminished ability to retaliate after the overnight Israel attack on Iranian nuclear, ballistic missile and regime leadership targets explains why the S&P 500 isn't falling more sharply and why the VIX "fear index" is nowhere near extreme levels. Expectations that the conflict won't spiral have thus far contained the jump in oil prices, which will limit any economic and inflationary impact.
Yet that relative calm is already being tested, with Iranian missiles now falling on Israel. President Donald Trump warned Iran on Friday that it needs to give up its nuclear ambitions before "even more brutal" attacks from Israel. Tehran isn't listening and has threatened to exact revenge not just against Israel but the U.S. as well. Experts also warn of a possibility that Iran could race to produce a nuclear bomb, a risk that might take U.S. weaponry to eliminate.
Israel-Iran Conflict In Focus This Weekend
Prior to Israel's overnight strikes, the U.S. and Iran were scheduled to resume talks over a nuclear deal in Oman on Sunday. But Iran announced it won't attend and has stepped up retaliatory strikes. Prime Minister Benjamin Netanyahu said that the Israeli offensive will continue as many days as needed to end the threat.
Trump will travel to Canada for a summit of G7 leaders at which the Israel-Iran conflict and possible sanctions of Russia will dominate discussions. The European Union is weighing further sanctions on Russia to push back against its ongoing operations in Ukraine, including those targeting the general public. The EU's latest proposal involves lowering a price cap on purchases of Russian oil to $45 a barrel, which could lead Moscow to pull back supply.
Iran's Weakened State
In a note following Israel's overnight strikes on Iran, Daniel Shapiro, who served as U.S. ambassador to Israel under President Barack Obama, wrote that "Iran has never looked weaker, and its ability to respond meaningfully will be tested."
Shapiro, writing on the Atlantic Council's website, wrote that Iran's strategic position has collapsed in the wake of Hamas' Oct. 7, 2023, attack on Israel. "Tehran's Lebanese proxy, Hezbollah, and its key regional ally, the Assad regime in Syria, lie in ruins," he wrote. While Iran's two attacks against Israel last year "produced little damage," Israel delivered a blow to Iran's air defense systems last October that helped lower its guard against last night's attack.
With Trump's diplomatic effort to end Iranian enrichment of weapons-grade uranium, Shapiro wrote that the president may face a decision "whether to use the United States' unique capabilities to destroy Tehran's underground nuclear facilities" to prevent completion of a nuclear weapon.
Will Iran Pull Its Punches?
S&P Global Market Intelligence wrote following Israel's attack on approximately 300 targets that Iran's initial response with about 100 drones was unlikely to be the full extent of the retaliation. The analysts expect Iranian "ballistic missile salvos targeting (Israel's) military and nuclear infrastructure, with such a strike likely to be calibrated to attempt to avoid wider escalation."
Iran launched missiles on Friday afternoon, New York time, with Israel's air defenses intercepting many, but several hit targets.
S&P Global doesn't expect either side to target civilian infrastructure or energy assets. However, if Iran's leaders see an existential risk, with Israel pursuing regime change, their response "would very likely entail strikes against critical Gulf infrastructure," S&P Global says.
In a Friday note, Lazard said that it doesn't anticipate Iran will disrupt Strait of Hormuz traffic, though it could happen if Tehran thinks doing so could provide it with an economic bargaining chip. Doing so "could push oil prices upwards of $120 per barrel."
Wall Street, S&P 500 React To Israel-Iran
"$80 per barrel in crude is an important psychological level for the markets," noted Kristian Kerr, head of market strategy at LPL Financial, following Israel's attack. "If we start seeing prices move above there due to escalation, the risks could become more widespread from a broader market perspective."
Friday afternoon, crude oil futures jumped 8.25% to $73.60 a barrel, well off the day's high around $77.58. Notably, Israel did not strike Iranian energy assets, perhaps a concession to President Trump.
The S&P 500 is off 1.1%, near session lows amid Iran's missile attack on Israel.
Meanwhile, the Cboe Volatility Index, or VIX, is up nearly 18% to 21.22. That's crossed into nervous territory above 20, but there's no hint of panic. Back in early April, the VIX briefly crested 60 as markets panicked over Trump's "reciprocal" tariffs.
Be sure to read IBD's The Big Picture column after each trading day to get the latest on the prevailing stock market trend and what it means for your trading decisions.
