The S&P/ASX200 fell 8.6 points on Thursday, down 0.1 per cent, to 8,525.7, as the broader All Ordinaries lost 18.8 points, or 0.21 per cent, to 8,726.5.
Traders are closely watching for any progress in communications between US and Iranian officials following early reports Tehran has rejected a 15-point peace plan and issued its own demands for de-escalation in the Persian Gulf.
The talks came with thousands of US troops and other military assets bound for the region, raising questions about whether the extra force would be used for leverage in negotiations, or to secure the Strait of Hormuz by force.
"There's some signs we could be heading towards a fairly significant escalation over the weekend that could catch markets off guard," Capital.com senior market analyst Kyle Rodda said.
"On the surface of things, we're seeing the markets pricing out the risk of escalation, and that's resulting in the lower oil price, boosting stocks, gold and currencies that aren't the US dollar, but to what extent that's an efficient representation of markets for pricing-in the future is a bit more questionable."
Perhaps in a sign of the direction traders were leaning, defence stocks outperformed the broader market, with Droneshield and Electro Optic Systems each up more than four per cent.
Airlines were again under pressure, with Qantas and Virgin dipping after Wednesday's relief rally.
Local energy stocks rebounded from selling off the previous session as oil edged higher, while Woodside and Santos each gained more than two per cent.
Woodside announced it assumed control of the Beaumont New Ammonia facility in Texas, which has the capacity to produce and export up to 1.1 million tonnes of ammonia each year.
Basic materials sector cooled off from Wednesday's rebound as gold miners sold off, while the precious metal eased to $US4,491 an ounce.
Mega miners BHP and Rio Tinto made modest gains, while Fortescue retreated against a steady backdrop for iron ore futures.
The heavyweight financials ended the session marginally better than flat, with CommBank and Westpac edging higher while NAB and ANZ lost ground.
In company news, bourse operator ASX dipped one per cent as it appointed former Cboe CEO Vic Jokovic as a non-executive director.Â
He will join the board in May.
AMP announced Adrian Ryan we be acting chief financial officer, to work in Blair Vernon's stead when Mr Vernon takes the reins as CEO on March 30.
Mobile marketplace and gig economy app operator Airtasker rose 2.2 per cent after inking a strategic deal with Nine Entertainment worth $5 million to boost the platform's brand awareness.
The Australian dollar is buying 69.47 US cents, down slightly from 69.72 US cents on Wednesday at 5pm AEDT, as higher local interest rate expectations brushed up against strength in oil prices and the greenback.
ANZ economists expect the Reserve Bank to effectively reverse 2025's interest rate easing cycle via a combined 0.75 per cent in increases to 4.35 per cent by the end of 2026.
"The economic outlook has weakened, shaped by higher inflation from domestic pressures and the Middle East conflict and the resultant monetary tightening and activity impacts," ANZ senior economist Adelaide Timbrell said.
ON THE ASX:
* The S&P/ASX200 dropped 8.6 points, or 0.1 per cent, to 8,525.7
* The broader All Ordinaries fell 18.8 points, or 0.21 per cent, to 8,726.5
One Australian dollar trades for:
* 69.47 US cents, from 69.72 US cents at 5pm AEDT on Wednesday
* 110.81 Japanese yen, from 110.84 Japanese yen
* 60.12 euro cents, from 60.14 euro cents
* 52.03 British pence, from 52.12 British pence
* 119.80 NZ cents, from 119.96 NZ cents
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