Stocks Drop as Interest-Rate Hike Odds Surge Amid Iran Conflict

North American markets are under renewed pressure as escalating geopolitical tensions in the Middle East reshape the outlook for both stocks and interest rates. With the war in Iran driving oil prices higher, investors are increasingly concerned about rising inflation and the growing likelihood of additional interest-rate hikes in 2026. As a result, major indices like the S&P 500 and Toronto Stock Exchange (TSX) have pulled back, while energy stocks emerge as a rare bright spot.

How Is the War in Iran Impacting Stocks?

Geopolitical tensions in the Middle East have been good for energy stocks. Over the last month, it’s been the only sector reporting gains (+9.4%). The energy sector is also the top performing sector over the last three months (+34.95%), half year (+34.36%), and year to date (+31.69%).

The rest of the stock market has been taking a big hit. The S&P 500 and TSX have both recorded four straight weeks of declines. The S&P 500 is at its lowest level since September 2025, while the TSX has erased three months of gains. The TSX was actually at a record level before the U.S. and Israel began bombing Iran on February 28.

While Wall Street was bullish on the S&P 500 heading into 2026, the war in Iran has led to many forecasters having to rethink their outlooks. At the start of 2026, Goldman Sachs expected the S&P 500 to rally 12% in 2026 and a further 10% in 2027.

In late March, the Wall Street firm said that the S&P 500 risked falling into correction territory, which is defined as a drop of 10% or more. As of March 23, the S&P 500 is down 3.8% year to date.

JPMorgan initially predicted that the S&P 500 would rally close to 10% this year. Due to the war in Iran and economic uncertainties, the bank has now cut its year end target from 7,500 to 7,200; this implies upside of 5.1%. The bank also said that the S&P 500 could fall to a low of 6,000 over the near term. That would imply downside of approximately nine percent.

How Will the War in Iran Impact Interest Rates?

Stocks fell on March 18 after U.S. Federal Reserve Chair Jerome Powell left the central bank’s policy rate unchanged, in the range of 3.5% to 3.75%.

What will the Federal Reserve do for the rest of 2026?

The odds of an interest-rate hike have actually increased significantly since the start of the war in Iran when fears of inflation clouded the picture, with the odds of an interest rate hike by September jumping to 75%. Before the Fed’s announcement, the financial markets priced in two interest-rate cuts by the end of 2026.

A more optimistic Wall Street expects that the Federal Reserve will hold its key interest rate before announcing a quarter-point cut in 2026, followed by one more in 2027. This would take U.S. interest rates to a range of 3.0% to 3.25%.

The Bank of Canada announced its interest rate policy on the same day as the Federal Reserve. As expected, the Bank of Canada held its overnight lending interest rate at 2.25%, a rate it has held since October 2025. The central bank highlighted the inflationary impact of higher oil prices coupled with a weak Canadian economy.

The Bank of Canada is facing a bit of a dilemma right now. Increasing interest rates to combat inflation could weaken the Canadian economy. Meanwhile, lowering interest rates to help support the Canadian economy could result in higher inflation.

Right now, Bay Street believes there is a 20% chance that the Bank of Canada will raise its interest rates when it meets next on April 29. Before the war, the odds of an April interest-rate hike was approximately four percent.

The markets think that, by year-end, the Bank of Canada could potentially raise its overnight lending rate by 75 basis points. If that were to happen, interest rates would hit 3.0%. Raising interest rates, even by 25 basis points, during a period of economic weakness, would further negatively impact Canadian businesses and households.

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With geopolitical risks rising and central banks facing difficult decisions on interest rates, market conditions are becoming increasingly complex for investors. Understanding how factors like inflation, energy prices, and global conflict influence the outlook for the S&P 500 and broader markets is critical to making informed trading decisions. For those looking to navigate this uncertainty with greater confidence, gaining the right knowledge and strategy has never been more important.

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