How US financial markets react to geopolitical shocks hitting oil supply

This box assesses how energy supply disruptions associated with geopolitical shocks are transmitted to US financial markets, leveraging on the indicator developed by Iacoviello and Tong (2026). Whereas negative geopolitical events typically reduce output, they are ambiguous with respect to inflation. However, those that also constrain global oil supply are inflationary and lead to deeper recessions. In these cases, stock prices fall more persistently, the dollar appreciates markedly, and risk metrics such as corporate bond spreads increase and remain elevated. This pattern is driven by oil price dynamics: instead of falling, as they would if supply were unaffected, oil prices rise sharply and persistently. Applying model-implied elasticities to the war in the Middle East which started in February 2026 suggests that markets have reacted only moderately to the shock. This may reflect confidence in the robustness of the US economy or expectations that the conflict will be short-lived, but it also leaves markets vulnerable to abrupt repricing if these assumptions prove wrong.