Rewrites with fresh quotes, updated prices, market reaction throughout

By Suzanne McGee, Gertrude Chavez-Dreyfuss and Yoruk Bahceli

NEW YORK/LONDON, March 2 (Reuters) - Investors are looking past the initial drama in the Middle East, with their hopes of a swift resolution to the crisis giving them confidence in buying the dip.

While markets on Monday had knee-jerk moves to the U.S. attacks on Iran, many of the initially more severe asset price moves moderated later in the trading day. Oil prices jumped but closed below their session highs. Stock markets across Europe fell but U.S. indexes .SPX had erased early losses to rise by afternoon trading.

"The main scenario that the market is pricing in right now is that there will be a prompt solution to this conflict," said Jacob Taurel, managing partner of Activest Wealth Management.

Investors said the market reaction was muted on Monday due to a general awareness that action in Iran was likely, leading to risk-off trading on Friday ahead of the move.

"This was all pretty well-advertised that action was coming," said Michael O'Rourke, chief market strategist at JonesTrading in Stamford, Connecticut. U.S. President Donald Trump had expressed disappointment on Friday about U.S. negotiations with Iran over its nuclear program.

"The build-up in forces was visible to us," said Ali Meli, founder and chief investment officer of private credit manager Monachil Capital Partners LP. "Generally, people were just hedging things... That's why today's reaction is very much muted."

Other factors that fed into Monday's trading were a buy-the-dip mentality in markets, an expectation that generally geopolitical impacts on markets fade and a view that the conflict would be soon resolved, strategists said.

Geopolitical events that have caused knee-jerk reactions include Russia's 2022 invasion of Ukraine, Trump's 2025 call for broad tariffs and subsequent negotiations with individual countries, and this year's U.S. intervention in Venezuela.

However, geopolitical events do not typically cause sustained volatility for equities, Morgan Stanley analyst Michael Wilson said in a note, adding that in the months after these occurrences, the S&P 500 typically rises.

Analysts at J.P. Morgan said in a note they expected a one-to-two-week decline in prices of riskier assets, but that would create "a buy-the-dip opportunity as the market looks through the initial pullback."

While the major U.S. equity indexes showed a muted response, there was more evidence of a reaction below the market's surface.

The S&P 500's energy sector .SPNY was up 1.8% in afternoon trading, reflecting the rise in oil prices. Shares of defense companies were also higher. Shares of Northrop Grumman NOC.N and RTX RTX.N both gained about 5%, while the iShares U.S. Aerospace & Defense ETF ITA.Z rose over 2%.

Meanwhile, the S&P 500 consumer discretionary sector .SPLRCD was off 1%, as investors pointed to concerns that higher gas prices would eat into consumers' discretionary spending.

TAIL RISK

The biggest risk for markets is the uncertainty over what happens next in Iran, given the complexities of the Islamic Republic's ruling system.

That then complicates the outlook for oil prices which have gained for weeks and are now hostage to what oil-producing countries do and how the passage of tankers through the Middle East is affected, with big implications for inflation worldwide and even the safety of bonds.

Market scenarios have mostly assumed the fallout will be limited, like it was during last June's "12-Day War" in Iran, rather than repeating the 2022 spike in oil caused by Russia's invasion of Ukraine.

Brent crude futures <LCOc1> rose as much as 13% to $82.37 a barrel, the highest since January 2025, before settling up $4.87, or 6.7%, at $77.74 a barrel. That remains far below the $100 level analysts reckon Brent would exceed in a prolonged conflict.

"What we're all worried about is whether we are going to see a repeat of 2022, where both bonds and equities routed as markets deliberated the longer-term energy supply implications," analysts at TS Lombard said.

"The situation remains very much up in the air, but we stand by our original position that this is a squall rather than a full blown oil crisis that tips the global economy into a sustained stagflation regime."

DOES HISTORY REPEAT?

Bond markets belied the calm in other assets, with yields rising as investors trimmed their rate cut bets across major central banks with the inflationary implications of pricier oil in mind.

U.S. Treasury yields shot higher.

"We see further (market) downside in the coming days," said Jefferies economist Mohit Kumar, who had already derisked last week on concerns markets were complacent on geopolitics.

"At some point we would be ready to buy the dip, but that some point seems far for now."

Some analysts expect Iran will not be able to disrupt trade in the Gulf region and the impact on oil prices will be contained.

"We wouldn’t be surprised if any selloff in the S&P 500 on Monday morning turns into a rally, driven by expectations of lower oil prices once the latest Middle East war ends," said Ed Yardeni, president of New York-based Yardeni Research.

"The price of gold might also round-trip on Monday. Bond yields might fall due to both safe-haven demand and post-war prospects for lower oil prices," he said.

(Reporting by Suzanne McGee, Gertrude Chavez-Dreyfuss, Anirban Sen, Lewis Krauskopf, Laura Matthews and Caroline Valetkevitch in New York, Gregor Stuart Hunter in Singapore and Alun John and Yoruk Bahceli in London; Writing by Vidya Ranganathan and Megan Davies; Editing by Megan Davies, Nick Zieminski and Nia Williams)

((vidya.ranganathan@thomsonreuters.com;))