The midterms could lead to less aggressive tariffs, BofA says By Investing.com

Bank of America warned that a longer Middle East conflict could push gas prices higher and that the U.S. midterms may influence Washington’s response, with markets potentially underpricing an extended war. On trade, the bank expects midterm politics to moderate tariff policy, with effective tariff levels likely settling in the 6%-8% range after the IEEPA ruling and Section 122 tariffs expiring in July. Near-term catalysts include factory orders and remarks from a Federal Reserve official.

Analysis

The main market implication is not the headline conflict risk itself, but the election-driven asymmetry in policy response. As gas prices rise into the midterm window, Washington’s tolerance for prolonged external shocks falls, which increases the probability of ad hoc de-escalation pressure, strategic reserve signaling, or softer tariff enforcement before any durable geopolitical resolution. That creates a near-term ceiling on “panic” pricing in equities, but also a false sense of safety if investors assume policy will offset the shock quickly.

The second-order winner is U.S. domestic inflation hedging: energy producers, pipeline-linked cash flow, and select refiners can outperform if crude remains bid while the rest of the market reprices for slower growth and stickier input costs. The bigger loser is cyclicals with thin margins and high import exposure, especially industrials and retailers that cannot pass through costs fast enough. If tariffs stay capped, that helps importers at the margin, but it also extends pressure on companies that had expected policy relief from reshoring/section 232 leverage.

The market may be underestimating duration risk. A “few weeks” conflict view is exactly where downside convexity is highest: if resolution slips into the next 1-2 months, the election calendar turns fuel prices into a political variable, making volatility persist even if the direct headlines fade. The contrarian setup is that tariff restraint could offset some inflation impulse, so the cleanest bearish expression is not broad index shorting, but a relative trade against margin-sensitive domestic demand names versus energy or inflation beneficiaries.

In the base case, this is a tactical volatility trade, not a structural regime shift. The best risk/reward is to buy optionality around energy and rate-sensitive downside, while avoiding crowded outright longs in oil unless the supply disruption broadens beyond the current chokepoint narrative. If crude rolls over quickly, the unwind can be violent because positioning is likely leaning on a persistent geopolitical premium that policy makers have a strong incentive to suppress.

Key Decisions for Investors

• Long XLE / short XLI for 4-8 weeks: favors energy cash flow over industrial margin compression if crude stays elevated; target 5-8% relative outperformance, stop if oil retraces sharply and headlines de-escalate.
• Buy OTM puts on XRT or KRE into the next 2-6 weeks: domestic demand and credit-sensitive names are the cleanest losers if gasoline prices rise and risk sentiment deteriorates; use defined risk because tariff restraint could cushion the move.
• Short IWM vs long XLP for 1-2 months: small caps are more exposed to input-cost pressure and weaker pricing power, while staples can pass through costs; attractive if higher fuel prices persist into the midterm window.
• Add near-dated call spreads in XLE or USO rather than outright longs: this captures a tactical spike in oil without taking full downside if a policy-led resolution emerges in days to weeks.
• Monitor BAC as a sentiment proxy for policy/tariff beta rather than a fundamental long: the note itself is more important for cross-asset positioning than the stock; fade any knee-jerk rally in rate-sensitive cyclicals if gas prices keep trending higher.