Could the Middle East War Cause a Major Market Sell-Off This Year?

The U.S. stock market is down less than 3% since the beginning of the war in the Middle East. That's a pretty modest decline, given that the ongoing conflict has resulted in an almost complete drop-off in shipping traffic through the Strait of Hormuz and a resulting oil price spike that has driven the price of Brent crude from about $72 to over $100 a barrel, a 40% increase.

But what would have to happen to cause a full correction in the stock market, which is typically defined as a drop of 10% or more?

Image source: Getty Images.

Deutsche Bank recently examined past market disruptions caused by geopolitical crises to identify common factors that could trigger a 15% or larger drawdown in the S&P 500 (SNPINDEX: ^GSPC). The investment bank came up with three scenarios that could drive the market down that much.

Three ways the S&P 500 could drop

The first scenario is an oil price spike of 50% to 100% that persists for several months. While the price of Brent did spike briefly to around $120 a barrel, a nearly 70% increase, those price levels didn't last long, and crude settled back to near $100. To spark a recession, oil would have to rise above $107 a barrel and remain there for months.

Remember that since 2019, the U.S. has been a net exporter of petroleum products, and it's also much more energy efficient than in decades past. So higher oil prices do considerably less damage to the economy today than they once did.

The second scenario is an oil price shock that tips an already slowing economy into recession. That raises the question of how healthy the U.S. economy was before the war began. The U.S. economy has been slowing in recent quarters. The annual growth rate fell to 1.4% in the fourth quarter of 2025, down from 4.4% in the third quarter. And the economy shed 92,000 jobs in February while the unemployment rate ticked up to 4.4%.

But the economy is still growing, and the jobless rate remains low by historical standards. The Federal Reserve Bank of Atlanta estimates the economy is growing at a 2.7% pace this quarter. So the U.S. economy is in relatively good health.

Finally, a sharp, hawkish pivot from central banks in response to the oil spike could send many economies, including the U.S., into recession, Deutsche Bank says. The Fed's interest rate-setting committee meets this week and will announce any changes to monetary policy on Wednesday afternoon. Few analysts expect the Fed to move its target interest rate at this meeting. And futures markets are now pricing in one quarter-point rate cut this year, not a hike.

Right now, none of the conditions that would push the U.S. economy into recession are in effect. And Polymarket, the largest prediction market, puts the chances of a U.S. recession at 31%. That sounds about right to me.

Matthew Benjamin has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.