Wall Street prophet Yardeni: Oil price shock may trigger "1970s-style stagflation," probability of U.S. recession rises to 35%

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As the war between the US and Israel against Iran enters its second week, oil prices continue to rise. Veteran Wall Street strategist Ed Yardeni has sharply downgraded the optimistic outlook for US stocks, warning that the market is approaching the edge of a bear market.

Yardeni raised the probability of a US recession in 2026 from 20% to 35% and slashed the likelihood of a stock market "melt-up" scenario from 20% to just 5%.

He wrote in a research report released last Sunday that the oil price shock will not abate until the Strait of Hormuz reopens. "Until then, financial markets may become increasingly concerned about a 1970s-style stagflation scenario—that period of stagflation was accompanied by two recessions."

Market sentiment is clearly under pressure. S&P 500 futures fell more than 2% at one point during Asian trading hours, and later recouped some losses. The VIX fear index surged to its highest level since the tariff turmoil in April. Hedge funds simultaneously increased short positions in US equity ETFs. The yield on the 10-year US Treasury rose 4 basis points to 4.18%.

Oil Prices Dominate Market Sentiment, Stagflation Risk Rises Sharply

Yardeni pointed out that oil prices are currently the main factor affecting market sentiment. Surging energy prices hit the economy in two ways: first, by directly raising consumer expenditure, and second, by increasing corporate production and transportation costs, thereby intensifying overall inflationary pressure. When inflation rises while economic growth is suppressed, stagflation risks emerge.

On the prediction market platform Polymarket, the probability of a US recession in 2026 has jumped from 22% at the start of last week to 34%, confirming that the market's concerns about stagflation are heating up rapidly.

Yardeni noted that the surge in oil futures accompanies a rise in US Treasury yields, a strengthening dollar, and a fall in gold prices—multiple signals suppressing the market's risk appetite. The dollar has become the safe haven of choice in the current conflict, with the Bloomberg Dollar Spot Index up nearly 2% since the outbreak of the war.

"The economy and US stock market are currently squeezed between the Iranian situation and difficult circumstances, and so is the Fed," Yardeni wrote. "If the oil price shock persists, the Fed's dual mandate will be caught in a dilemma—both inflationary risks and pressure from rising unemployment will intensify."

S&P 500 and Nasdaq Face Risk of Losing Technical Support

On the technical front, Yardeni believes that the S&P 500 and Nasdaq 100 indices are now in a "precarious" position. He predicts that both indices may soon fall below their respective 200-day moving averages—a long-term trend indicator usually considered an important technical support level.

Last week, Yardeni was among the first to warn that, impacted by the Middle East war, the S&P 500 faces a risk of 10% to 15% correction. Further surges in oil prices have made him even more cautious.

"Now, we cannot rule out the possibility of a bear market or even a recession. All of this obviously depends on how long the Strait of Hormuz remains closed," he said. Typically, a decline of 20% from recent highs constitutes a technical bear market.

The S&P 500 fell 2% last week, while the broader global equity benchmark, the MSCI World Index, dropped 3.7% in the same period. By comparison, the resilience of the US market partly stems from its higher energy self-sufficiency, and previous concerns over AI spending and business disruptions have already absorbed some upward momentum.

Bond Market's Safe Haven Logic Also Tested

Under a stagflation scenario, the logic of the bond market as a safe haven may also fail. Yardeni noted that the yield on the 10-year US Treasury has been "unusually calm" over the past year, remaining stable within the 4.00% to 4.25% range.

"Surging oil prices could break this calm and push yields to higher levels," he said. The market has now postponed expectations for the Fed's next 25-basis-point rate cut to September.

On Sunday evening, Trump said the short-term pain caused by military action against Iran is worth it, and called $100 oil prices "a small price to pay," which further increased worries that the conflict may persist.

Extremely Depressed Sentiment May Be a Contrarian Buying Opportunity

Despite issuing multiple warnings, Yardeni has not completely given up on his medium-term optimistic forecast. He maintains his "Roaring 2020s" base scenario unchanged, believing the US economy still has a 60% chance of robust expansion supported by strong productivity growth, and assigns an 85% probability for this scenario to continue over the next decade. He puts the likelihood of a repeat of the 1970s stagflation at 15%.

Notably, Yardeni also said he is preparing for when market sentiment becomes excessively pessimistic. "As we've pointed out before, geopolitical crises often create buying opportunities for stocks. In the coming days, bearish sentiment may spike, which could be a contrarian buying signal," he wrote.

Yardeni has a track record in market calls. Last December, he suggested underweighting the "Magnificent Seven" tech giants in the S&P 500, and since then the tech sector has lagged behind the broader market markedly.

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