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Geopolitics are back in the spotlight Friday after a U.S. military strike killed the head of the Iranian military and Iran vowed retaliation. Markets are rattled, casting doubt on signs of a global economic recovery that had been pushing markets higher.

President Donald Trump ordered the Iraq airstrike that killed Maj. Gen. Qassem Soleimani, leader of the foreign wing of Iran’s Islamic Revolutionary Guard Corps. On Friday, the State Department’s Mike Pompeo said the strike was a response to an imminent attack. The developments surprised politicians and investors and escalated tensions in the Middle East and raising fears it could spark a regional war and draw the U.S. into an armed conflict.

S&P 500 futures fell 1.3% while currencies like the Japanese Yen and the U.S. dollar rose as investors piled into havens overnight, sending and gold and oil higher. The SPDR Gold Shares (GLD) rose 1.2% to 145.70.

In a note to clients, Marc Chandler, chief market strategist at Bannockburn Global Forex, offered a list of geopolitical developments in just the last couple of days. Apart from the killing of the Soleimani, Turkish forces are going into Libya while North Korea’s Kim Jong Un is no longer promising to halt nuclear-weapons testing. Though the market typically ignores geopolitical considerations, they were front and center in low-volume, post-holiday trading, sapping risk appetite, Chandler said via email.

For now, most strategists cautioned that markets tend to overreact to geopolitics in when trading is thin. Plus, equities are ripe for profit-taking and priced for perfection, given recent highs. But they also warned that the news was significant for any time of the year.

The Sevens Report’s Tom Essaye underscored the importance of the development, likening the killing of Soleimani “to a foreign government assassinating our Secretary of Defense and our Secretary of State. “Point being, this was significant action. Retaliation from Iran is expected and all U.S. military assets in the region are on high alert,” he wrote, adding that a regional war wasn’t priced into the markets and could easily push the S&P 500 down 5% to 10% from a reaction to the spike in oil prices alone.

In an email, Brian Nick, chief investment strategist for Nuveen, said recent conflicts between the U.S. and Iran have triggered short-lived geopolitical flare-ups. The main implications will be for countries and assets tied to the Middle East and Africa—including sovereign and corporate debt and international energy companies—with limited impact to global markets, for now.

“While the radical decentralization of energy production, especially in the U.S., hasn’t made the Middle East a less geopolitically volatile place, it has limited the degree to which political and military conflict in the region spills over into markets in North America, Europe and Asia,” Nick wrote. “Absent a material escalation that encompasses a larger part of the region, we believe this remains the most likely outcome this time around, as well.”

But that’s not to say there won’t be any global market impact, especially as valuations had risen on the view policy risks had decreased—a perception that has likely been dashed with the latest developments. “It will be harder for stocks to snap back quickly if investors already perceive them to be overvalued,” Nick said.

Gold may spike in the near-term until the panic subsides and oil prices will likely rise much further only if there is a serious threat to oil supplies. Nick notes however that long-duration bond yields have room to fall back to at least their mid-2019 levels if the situation spirals further—and they also are unlikely to rise much even if this is a short-lived conflict.

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In a note to clients, Kit Juckes of Société Générale wrote that a protracted period of higher oil prices is now a risk given the scope for tension to persist in Straits of Hormuz. Juckes favors safe-haven currencies such as the Norwegian Krone against the U.S. dollar, which he thinks could gain even after a strong December.

And then there is the wider impact on the global economy to consider. Capital Economics has previously estimated that a U.S.-Iran conflict could shave half a percentage point off global economic growth or more. In a note to clients, Capital Economics said Iran’s retaliation could come in forms including attacks on U.S. embassies in the region, and even strikes on U.S. military facilities in the Gulf.

If the situation spirals into a full-blown military assault on Iran, the group said a resulting collapse in Iran’s economy could shave 0.3% percentage points off global GDP—about what they had estimated as damage from the trade war. The bigger impact comes through oil. Capital Economics has previously noted that if Iran tried to shut off the Strait of Hormuz, that could push Brent crude to $150 per barrel, boosting inflation globally by as much as 3.5% to 4% in Organization for Economic Cooperation and Development (OECD) countries.

A U.S.-Iran war would jeopardize Capital Economics’ base case for a bottoming in the global economy early this year with a recovery after that. Investor sentiment is likely to take a beating, which could hurt risky assets, including stocks and emerging-market currencies while boosting havens.

Write to Reshma Kapadia at reshma.kapadia@barrons.com