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President Donald Trump threatened to escalate the war with Iran on Saturday unless the country’s leaders rapidly reopen the Strait of Hormuz. Publicly, Trump and Iran’s leadership appear far apart on terms for a ceasefire, and the war may be about to intensify. Yet both sides also have good reasons to seek off-ramps.

What comes next? Giles Alston, senior analyst at Oxford Analytica, outlines three routes the president could take:

Declare victory and withdraw. This would ease concerns about another “forever war,” but would likely leave Iran in control of the Strait of Hormuz.

Escalate attacks. Trump could follow through on threats to attack Iranian power plants, risking further Iranian retaliation against Gulf states and infrastructure. If the gambit works, Iran could be forced to reopen the strait. The cost: an extended conflict with greater damage to the global economy. 

Occupy southern Iran. The U.S. could bomb and occupy parts of southern Iran to secure the strait. This would involve significant U.S. casualties and an extended campaign without an obvious exit strategy. 

“Economic problems persist in any scenario, but escalation is worse,” Alston notes, adding that the cost to the global economy would be steep. Trump’s domestic standing would also take a hit. For those reasons, Alston believes Trump will opt to declare victory and withdraw.

Even the path of least resistance, however, has economic repercussions. Withdrawing soon raises the risk that Iran will continue to control the strait, leaving many shippers and insurers unwilling to risk passage and keeping energy prices high.

Oxford Analytica analysts Sarah Fowler and Tatia Bolkvadze estimate that the war will shave about a percentage point off global economic growth, taking it down to 2% this year. Growth forecasts for large, developed economies—Japan, France, Germany, Italy, and the United Kingdom—were modest before the war at around 1%. If the conflict extends past June, GDP growth for these countries could evaporate, while inflation keeps rising.

The situation puts central banks in a bind on inflation and interest rtes. They could raise rates preemptively, risking a deeper downturn; if they wait for prices to rise more, they risk falling behind the inflation curve.

Among developed markets, the U.S. is in a better spot. The country has a domestic surplus of natural gas and oil that should help offset rising energy prices. Federal Reserve Chair Jerome Powell said this week that U.S. interest rate policy was “in a good place” and that the Fed could wait for oil prices to come down.

The economy’s underlying strength is likely why U.S. equities have fared slightly better than other developed markets’ since the war broke out. The S&P 500 is down 4.3% since Feb. 27, while the iShares Core MSCI International Developed Markets ETF is off about 7%.

Many strategists see a snapback rally on signs of real progress in ending the war. “When resolution comes, and it will come, in some form, because it always does, the snapback in quality will be VIOLENT and fast,” wrote Mark Malek, CIO at Siebert Financial, in a note.

The drawdown presents an opportunity to buy high-quality tech names such as Microsoft, Nvidia, Apple, and Alphabet, he notes. David Bianco, Americas chief investment officer at DWS, maintains a 7,500 target for the S&P 500, acknowledging that while the war presents downside risk, the index is “resilient against an oil shock.” The S&P 500 closed at 6,583 on Thursday.

Eurozone and Asian countries dependent on Gulf oil face more pressure. European Central Bank officials have hinted that rate hikes are on the horizon. Markets are pricing in an 88% probability of the ECB raising rates by a quarter percentage point at its April meeting.

A more hawkish ECB will limit the scope for a sustained rally in long-term European bonds, according to Gavekal Research. That makes U.S. bonds—and the dollar—a more attractive option than other developed markets. Yields dipped slightly last week after spiking in March, an encouraging sign. 

Eric Fine, head of emerging markets active debt at VanEck, sees opportunity in emerging market bonds.

Latin America is well positioned, he says. Many countries in the region are net oil exporters, which could help them benefit from higher oil prices. VanEck Emerging Markets Bond ETF emphasizes government debt from Brazil, Peru, Mexico, and Colombia, among others. 

While Latin American countries have some oil revenues to offset economic damage, an extended conflict would be more harmful for developing economies that depend on imported energy and external debt—especially those with large debt vulnerabilities, such as Bangladesh, Pakistan, Zambia, Ghana, and Senegal, according to Oxford’s Fowler and Bolkvadze.

NATO’s Latest Defense Crisis

Trump’s disdain for NATO got louder with the president saying he was “absolutely” considering pulling the U.S. from the treaty. A major gripe: European leaders denying the U.S. military support in Iran.

Trump can’t easily pull the U.S. out of NATO on his own. A 2023 law requires the president to get congressional approval to withdraw from the treaty. Administration officials have said the president has the executive authority, but any move would likely face legal challenges.

That said, there are a “whole range of things” Trump could do to undermine the alliance, short of withdrawing, such as shifting troops from member bases or curtailing military exercises with NATO states, says Byron Callan, manager at Capital Alpha Partners.

Trump’s threats will be top-of-mind as European nations begin discussing their 2027 budgets. With the U.S. making moves to scale back support for Ukraine as the war in Iran rages, countries close to Russia’s border may push for more military spending, says Callan. That could mean more upside for military contractors.

European military spending aims to reach 5% of countries’ GDP by 2035. If the U.S. were to withdraw from the alliance, Europeans will have to spend a higher share of GDP to make up for a U.S. funding shortfall, Callan says.

The U.S. troops and weapons buildup in the Middle East is also shifting priorities. The Pentagon needs to restock ammo, and American defense companies may need to prioritize production over profit margins. European defense companies don’t face that kind of pressure.

The Bottom Line: European defense stocks may have more to gain. One way to invest would be through the Xtrackers Europe Defense Technologies ETF. Launched in February, the fund owns big European industrials and defense suppliers such as Rhinemetall AG, BAE Systems PLC, Airbus SE, and Safran SA. The ETF is down 4.4% since the war started on Feb. 27, but it’s holding up better than the iShares U.S. Aerospace and Defense ETF, down about 9%.

Stocks Affected: BAE Systems (BAESY), Airbus (AEDSY), Leonardo (FINMY), Rheinmetall (RNMBY)

Trump Makes Another Tariff Push. Markets Are Moving On.

One year after Trump’s “Liberation Day” tariff blitz, the market is looking very different. Worries about tariffs have been displaced by the Iran war and global energy shock. While the president keeps making tariff threats, the market is prioritizing other issues.

Trump’s latest tariff push, on the anniversary of Liberation Day, targeted the pharmaceutical industry; the president unveiled a 100% tariff rate on imported patented pharmaceuticals unless companies pledge to bring manufacturing to the U.S.

Investors largely yawned. Eli Lilly, Johnson & Johnson, AbbVie, and 10 other big drugmakers companies were already working out agreements to lower prices and invest in U.S. manufacturing in exchange for lower tariffs temporarily. The stocks barely reacted.

The pharma tariffs come after legal setbacks for Trump’s first round of levies. Many of them—instituted under the International Emergency Economic Powers Act—were deemed illegal by the U.S. Supreme Court. The ruling ordered the government to reimburse roughly $175 billion that importers had paid over the past year, though the refunds are stuck in legal wrangling.

None of this means tariffs are going away. Duties remain higher, on net, than they were a year ago, made up of Section 232 tariffs, China-specific levies under Section 301, and the 10% global tariff the Trump administration announced after the court ruling.

But like the pharma industry, companies in other sectors are striking deals with the administration or taking steps to insulate themselves from tariff costs. DWS’s Bianco points to Tesla, which has invested heavily in U.S. plants.

Steel manufacturing is also seeing a renaissance. That’s partly because of tariffs on imported metals but also because of rising demand for data centers and electrification.

Indeed, while U.S. manufacturing “has been really tepid” this year, Bianco says, there are still bright spot in AI investment and a massive push to upgrade the grid and power generation. Those trends are fueling growth for equipment makers like Hubbell, Emerson Electric, Eaton, and Amtech Systems.

The Bottom Line: Trump’s tariffs look increasingly manageable while the economy proves resilient. Bianco notes that the S&P 500’s earnings momentum is still strong, despite the oil shock from the war. Analysts expect 17.8% earnings growth this year, higher than the prewar estimate of 14.6%. Assuming the war winds down soon, the economy should avoid a recession, while also skirting the worst of the tariffs.

Stocks Affected: Eli Lilly (LLY), Johnson & Johnson (JNJ), AbbVie (ABBV), Hubbell (HUBB), Emerson Electric (EMR), Eaton (ETN), Amtech Systems (ASYS)

Canada, Mexico, and Prospects for a New U.S. Trade Deal

• The USMCA (US-Mexico-Canada Agreement) expires in July, and the Trump administration’s demands are coming into focus.

• U.S. access to Mexico’s energy sector appears to be a priority, according to the latest U.S. Trade Representative’s National Trade Estimate, released annually.

• The report describes investment barriers to Mexico’s energy sector, dominated by state-owned entities such as Mexican Petroleum (PEMEX) and the electric utility, Federal Electricity Commission (CFE). “Private companies operating in Mexico are often unable to participate effectively, if at all, in Mexico’s energy sector,” the report states.