UBS Warns Iran Conflict Threatens US Debt

A prolonged conflict with Iran could lead to a significant "structural repricing of sovereign risk," according to some analysts. This comes as the U.S. economy already shows signs of vulnerability, including an unemployment rate of 4.1% and elevated delinquency rates for auto loans. Such a conflict could necessitate an immediate and unplanned debt issuance of $1.5 to $2.0 trillion to fund military operations. The most immediate economic shock would likely be to oil prices. A sustained disruption to the Strait of Hormuz, through which about 21% of global petroleum liquids pass, could cause Brent crude to surge to a sustained $150–$180 per barrel, with some analysts predicting spikes above $200. This would have significant inflationary effects, with estimates suggesting a sustained 20-30% increase in oil prices could depress global growth by 0.5% to 1.0% and raise global inflation by a similar margin. This inflationary pressure could complicate monetary policy, potentially deterring the Federal Reserve from anticipated interest rate cuts. Some economists suggest that a prolonged conflict, combined with existing tariff pressures, could even force the Fed to consider raising interest rates to combat rising prices. Historically, however, the Fed has often moved to support government financing and the economy during wartime, even at the risk of higher inflation. The conflict would also place additional strain on a U.S. budget already facing large deficits. The Congressional Budget Office has projected that interest payments on the national debt will reach $1 trillion in 2026. Increased military spending would add to this burden. The U.S. is projected to spend over $1 trillion on defense in 2026, a 13.4% increase, and a prolonged conflict would likely require supplemental spending on top of that. This fiscal pressure is a key reason all three major credit rating agencies have downgraded U.S. debt from their top ratings. A new conflict could further erode confidence. Analysts predict a conflict scenario could push the 10-Year Treasury yield towards 6.00%–6.50% due to inflation, increased fiscal strain, and a potential sell-off by major foreign holders of U.S. debt, like Japan. Investors would likely flock to safe-haven assets in the event of a prolonged conflict. This would include the U.S. dollar, Swiss franc, Japanese yen, and gold. Defense company stocks would also be expected to benefit from increased military spending. The U.S. military faces its own set of constraints. A 2023 report from the Center for Strategic and International Studies warned that a conflict with a major power could deplete certain U.S. munitions stockpiles in as little as a week. In a few days of operations against Iran in 2025, the U.S. military reportedly used a quarter of its entire stockpile of THAAD missiles. The current tensions follow a period of failed negotiations and escalating military actions. After talks in Geneva to revive a nuclear deal ended without a breakthrough, the U.S. and Israel launched joint strikes on Iran on February 28. This followed a U.S. military buildup in the region that included two aircraft carriers.