Fear of a war-driven inflation shock is overruling everything else in markets right now

• Market fallout from the Iran has been as expected, with one key exception.
• A sell-off in ultra-safe Treasury bonds shows that inflation worries are overruling everything else right now.
• If the Middle East sees prolonged disruptions, limited oil supply could lead to an inflation shock.

Up to this point, the market fallout from the Iran war has mostly gone as expected.

Oil spiked as much as 17% across two days as tanker traffic through the critical Strait of Hormuz froze. Stocks got crushed, especially on Tuesday, after the US ramped up attacks overnight.

But one part of the market has performed against-type: US Treasury bonds, which have sold off sharply, despite being generally viewed as a primary safe haven during macro volatility. What gives?

To put it simply: Investors are afraid of inflation above all else. The prospect of an inflationary shock has them rethinking the future of interest-rate cuts, so they're dumping Treasurys — pushing yields higher — and also selling stocks.

This market reaction could have wide-reaching implications for everyday Americans, given its relevance to President Trump's push for affordability ahead of midterm elections.

An inflation spike would undercut Trump's efforts to lower prices nationwide. Gas prices at the pump, which have recently been a bright spot in the inflation equation, are at risk of rising. Mortgage rates, which just broke below 6% for the first time in years, will likely bounce back up.

Trump has also shown himself to be sensitive to sizable spikes in the 10-year Treasury yield, like the one that's played out already. He wants easy lending conditions for businesses and US consumers, and a prolonged yield increase complicates that.

TACO trade enthusiasts might say to expect a walk-back in the policies that have inflamed yields. But the stakes of a war in the Middle East far exceed those of tariff threats. This isn't a situation that can be unwound.

As it stands now, the US has signaled that the Iran war could stretch for weeks. If it sticks to that plan, there's no telling how high oil might go, or how much stocks could fall. All of Wall Street's tail-risk scenarios are centered around that type of prolonged disruption of global oil flows.

So with Treasurys currently out of commission as a safe haven, where can investors hide out in the meantime? Gold might seem like a logical choice, since it's normally viewed as an inflation hedge, but it got shelled on Tuesday. For now, the greenback is looking like the best option, with the US Dollar Index up 2% across two days.

But the tough truth is that no situation is stable at the moment. The White House's messaging around Iran could flip on a dime, and so can how investors are viewing the macro picture. Stay tuned.