US-Iran Conflict Escalates: US Stocks Rise Instead of Falling, Treasuries Abnormally Plunge? Goldman Sachs: There Is More to the Story

TradingKey - Despite the escalating conflict in the Middle East and successive attacks on U.S. diplomatic facilities, the reaction of the U.S. stock market remained unusually calm. On Monday (March 2), Eastern Time, the three major U.S. indices opened lower but subsequently rebounded. By the close, the Nasdaq and S&P 500 both posted slight gains, while the Dow Jones Industrial Average narrowed its decline to 0.15%.

Another anomaly was the performance of U.S. Treasuries, which typically rise on safe-haven demand but turned lower after a brief period of strength. Treasury yields rose by 9-12 basis points during the day, with the 10-year Treasury yield reclaiming the 4.00% level and touching an intraday high of 4.06%.

Is this because the market is overly optimistic about U.S. stocks, or is there more to the story?

U.S. Stocks Defy Trends: Defensive Sectors Weaken as Market Prefers High Risk

Goldman Sachs (GS) stated they "could not make sense" of Monday's U.S. market movements: sector performance ran completely counter to expectations amid declining volume. According to Goldman Sachs data, volume tracking for Nasdaq 100 constituents showed a decline of more than 10%.

In terms of specific sectors, healthcare stocks fell sharply, with the S&P 500 Healthcare sector dropping over 1% on the day. While safe-haven capital typically flows into defensive sectors like healthcare when geopolitical risks escalate, this price action broke that pattern. Goldman Sachs noted that this was a classic anomaly.

Meanwhile, riskier tech stocks rose instead, with the Bloomberg index tracking the "Magnificent Seven" (ticker BM7T) advancing 0.41%, outperforming the S&P 500's 0.04% gain. Furthermore, software and SaaS sectors also saw significant rallies.

Looking at S&P 500 industries, energy was among the best-performing sectors of the day due to surging oil prices, while consumer sectors (both Staples and Discretionary), typically considered defensive, saw the largest declines.

U.S. Treasuries Slump: Inflation Fears Overwhelm Safe-Haven Demand

At the same time, U.S. Treasuries faced a significant sell-off on Monday, with yields rising sharply across the board: 2-year and 5-year yields increased by more than 10 basis points, while the benchmark 10-year yield rose by nearly 10 basis points, marking its largest single-day gain since June of last year.

Generally, rising geopolitical risks drive safe-haven flows into Treasuries. However, against the backdrop of the Strait of Hormuz blockade, the market appeared more concerned that rising oil prices would fuel inflationary pressures, thereby paring bets on Federal Reserve rate cuts.

This is because higher oil prices are quickly reflected in the prices of petroleum products like gasoline and diesel, and energy consumption carries a significant weight in the Consumer Price Index (CPI). In other words, oil prices are positively correlated with headline inflation. Consequently, when oil prices rise, market expectations for future inflation also increase.

The movement in Treasuries reflects another layer of market psychology: concerns over rising inflationary pressures are prevailing over geopolitical risks.

Investment Banks Warn of Short-Term Downside Risk

Goldman Sachs concluded that the market currently tends to "ignore" the short-term shocks of geopolitical conflicts, remaining bullish on the long-term benefits of AI trades and GDP growth for U.S. stocks, while simultaneously acknowledging increased inflation risks.

Goldman Sachs trader Dom Wilson’s team noted that while rising oil prices are typically bearish for equities and credit markets, they only truly impact overall economic growth when prices remain elevated for an extended period. They anticipate that, given the expectation that the U.S.-Iran conflict will not be resolved quickly and following strong positioning and gains in U.S. stocks since the start of the year, cyclical sectors and oil importers are more susceptible to pressure from position adjustments.

JPMorgan (JPM) on the other hand, believes that a significant portion of geopolitical risk may already be priced into equities, with stock pricing exceeding the assumptions of the futures strip (i.e., above the collective forecast for future oil prices). Consequently, they are maintaining restraint regarding the initial market euphoria and warning that risky assets could face a downside phase lasting one to two weeks.