New York CNN Business  — 

The American drone strike targeting a top Iranian commander sent shockwaves across previously calm Wall Street.

The dramatic escalation of tensions between the United States and Iran forced once-euphoric investors to confront the risk of a tit-for-tat spiral that derails the economy by depressing consumer spending.

Oil prices climbed 4% to three-month highs following the killing of Qasem Soleimani, the head of the Islamic Revolutionary Guards Corps Quds Force. Treasury yields tumbled as investors rushed to safety. The VIX (VIX) volatility index rose sharply.

“All heck is breaking loose on the geopolitical stage,” Bespoke Investment Group co-founder Paul Hickey wrote in a note to clients on Friday morning.

Investors are not panicking, though. US stocks buckled but didn’t break. The Dow retreated roughly 250 points, or 0.9%, giving back just part of the previous day’s sizable gains.

Iranian officials promised a “crushing response” for the killing of Soleimani, who is one of the nation’s most important figures.

‘Retaliatory spiral’ looms

The biggest risk is a military conflict that deals a blow to consumer confidence or unleashes a costly oil price shock.

“We think the stage is set for a retaliatory spiral that could keep markets on edge well into 2020,” Helima Croft, a former CIA analyst who now leads commodity strategy at RBC Capital Markets, wrote in a report Friday morning.

Anything that disrupts consumer spending would be a major problem for the US economy, because American households are arguably the strongest piece of the world economy right now. The US manufacturing industry, on the other hand, is mired in a trade-war-fueled recession.

“The primary issue, which no one knows, is how much retaliation may develop and on what scale,” Eric Freedman, chief investment officer at U.S. Bank Wealth Management, told CNN Business in an email.

Analysts at the Eurasia Group warned that the chance of a war has increased to 40% from 20% previously following Thursday’s US drone attack. However, the consulting group said a limited conflict lasting days is more likely than a months-long, regional conflict.

“One thing is clear: Iran will respond. Iranian leaders are proud and quite risk acceptant,” Henry Rome of the Eurasia Group wrote in a Friday report.

This risk led investors to buy defense and energy stocks Friday. Shares of defense contractors Northrop Grumman (NOC) and Lockheed Martin (LMT) jumped more than 3% apiece, making them among the best performers in the S&P 500. Oil drillers including Apache (APA) and Hess (HES) also advanced.

US officials said they were on the lookout for possible retaliatory actions from Iran, including the possibility of cyberattacks. Iranian hackers have previously been accused of cyber infiltrations on US banks, dams and other critical infrastructure.

Cyber concerns lifted security stocks, including Crowdstrike (CRWD) and FireEye (FEYE).

Turbulence in financial markets is a risk in itself. A sustained plunge in stock prices could dash confidence among households and CEOs alike.

Extreme greed is still here

Yet that does not appear to be playing out. Markets quickly bounced off their worst levels.

The CNN Business Fear & Greed Index remains in “extreme greed” mode. In fact, at a score of 94, the gauge of market sentiment remains just three points away from the record high set on Thursday.

“Individual geopolitical risks tend not to be sufficient to drive a sustained downturn in markets,” Mark Haefele, chief investment officer at UBS Global Wealth Management, wrote in a note to clients.

Others urged investors to take advantage of the rare selloff to find an attractive entry point into the previously red-hot stock market.

“We remain firmly bullish on tech stocks and the growth prospects of the coming year and believe any temporary risk-off trade is a golden buying opportunity rather than a time to retreat with the bears yelling fire in a crowded theater,” Daniel Ives, an analyst at Wedbush Securities, wrote to clients on Friday.

It’s also important to note that Friday’s oil price jump pales in comparison to the 15% spike in September after a devastating attack on Saudi Arabia’s oil infrastructure, which has been blamed on Iran. Even that surge proved fleeting, with prices quickly retreating after Saudi Aramco quickly got production back online.

There are hopes that cooler heads will ultimately prevail.

“Iran’s leaders probably aren’t suicidal; we doubt they will take action that will trigger air strikes on Tehran,” Ian Shepherdson, chief economist at Pantheon Macroeconomics, wrote in a Friday report.

The impact of the shale revolution

There’s also debate over the impact of oil spikes in the modern economy.

Clearly, a surge in oil prices above $100 a barrel would be painful to many Americans as well as airlines, trucking companies and other parts of the transportation industry.

Nicholas Colas, co-founder of DataTrek Research, has pointed out that oil shocks have killed more US economic expansions over the past 40 years than any other single cause. Recessions followed the 1973-1974 Saudi oil embargo and the Iranian Revolution of 1979, for instance.

Every $5 increase in oil prices is equivalent to an annualized tax of about $183 billion per year, or 0.1% of global GDP, according to Shepherdson.

At the same time, this is not the 1970s. Due to the shale revolution, the United States is now the world’s leading oil producer. Texas alone pumps more crude than most OPEC nations. That makes America less reliant on foreign oil than in the past.

All of this means that higher oil prices may no longer be a net negative for the US economy and could even be a net positive.

If anything, a spike in prices would force oil companies to rapidly spend more money to increase production. That in turn would spill over into the rest of the economy.

This thinking could help explain another reason why investors are not freaking out about the rising tensions with Iran – at least not yet.