Updates

Conflict in the Middle East from is far from over….

• Optimism surrounding the Middle East ceasefire was tested this week as reports emerged that a U.S. helicopter was struck by Iranian forces. The United States subsequently launched retaliatory strikes against Iranian targets, describing the operation as a lawful act of self-defense. Markets responded predictably with volatility rising sharply in the immediate aftermath. The episode serves as a pointed reminder that, despite incremental diplomatic progress, active U.S. military engagement in the region remains an ongoing risk and that the prospects for a permanent resolution are far from assured. 

• Last week’s May employment report exceeded expectations, marking the third consecutive month of stronger than anticipated payroll gains. The unemployment rate remained steady at 4.3%, a reading many economists attribute to an expanding labor supply — particularly among immigrant workers re-entering the workforce — keeping pace with demand rather than signaling a broader deterioration in the jobs market. 

• This morning’s May Consumer Price Index (CPI) release showed inflation rising 4.2% year-over-year, marking the highest reading since April 2023. Much of the increase was driven by elevated energy prices stemming from the ongoing Middle East conflict. Excluding the more volatile food and energy prices, core CPI still rose 2.9%, sharply higher than the Fed’s 2.0% target. Many economists believe this reading may represent a near-term high-water mark for inflation. However, this assumes that geopolitical tensions do not escalate further, and that energy prices begin to stabilize. 

• Meanwhile, Wall Street is eagerly awaiting the initial public offering of Elon Musk’s SpaceX later this week. The aerospace/social media/AI company is expected to debut at a valuation in excess of $1.7 trillion, implying a price-to-sales multiple exceeding 90 times 2025 revenues. Skeptics point to comparisons with the late1990s dotcom era when growth expectations frequently outpaced underlying fundamentals.  

Ceasefire, Yields, and a Fed Chair on Trial…

• Markets continue to swing sharply on developments surrounding a potential U.S.- Iran agreement. Despite intermittent military skirmishes earlier this week, negotiations have advanced with proposals to extend the current ceasefire and reopen the Strait of Hormuz for at least two months being considered. Several vital issues remain unresolved though, namely control over maritime traffic, the disposition of Iran’s uranium stockpiles, the release of frozen Iranian assets, and the terms of a broader ceasefire involving Lebanon. Until these issues are settled, the risk of a breakdown in negotiations remains substantial. As a result, investors should expect continued volatility in both energy prices and risk assets.

• Despite elevated geopolitical risks, Wall Street has continued to advance, propelled largely by the artificial intelligence trade. Equities, however, are not the only asset class registering significant moves. The 10-year Treasury yield surged sharply through early May before easing, yet they remain meaningfully elevated relative to early March levels — a reflection of shifting risk appetite and renewed inflation concerns tied directly to the energy markets’ disruption. If a formal agreement with Iran materializes, both oil prices and Treasury yields could retreat as geopolitical risk premiums unwind. Until then, the bond market is pricing in a more persistent inflation environment than are reflected in equity values.

• Reinforcing that concern, the Federal Reserve’s preferred inflation gauge — the Personal Consumption Expenditures Index — is due for release tomorrow. Consensus expectations call for headline PCE to rise 3.8% year-over-year with Core PCE projected at 3.3%. Both measures are also anticipated to accelerate on a month-over-month basis, suggesting inflationary pressures are broadening rather than fading. For a Fed already under intense political scrutiny, rising inflation reading would narrow policy options considerably.

• The new Federal Reserve Chair, Kevin Warsh, steps into this environment carrying significant uncertainty — not merely about the economic path ahead, but about his own independence. With the Trump Administration powerfully pressing for lower rates, and the labor market showing repeated continued signs of softening, how Warsh navigates the Fed’s dual mandate may prove among the most consequential monetary policy actions of the next several years.

Ever rising Federal debt amidst resilient growth and rising inflation pressures…

• Federal finances continue to deteriorate at a historically notable pace. Net U.S. federal debt now exceeds annual GDP for the first time since World War II with little indication of near-term improvement. The government currently spends roughly $1.33 for every dollar of revenue collected, while interest expense consumes approximately one out of every seven federal dollars. If left unaddressed, the trajectory places the U.S. on a path more commonly associated with highly leveraged developed economies such as France, Italy, Greece, and Japan. Over time, sustained fiscal imbalance risks extending beyond government accounts, placing upward pressure on borrowing costs across the entire American economy, including mortgages, auto loans, and consumer credit.

• Geopolitical tensions remain elevated despite the continuation of the U.S.–Iran ceasefire. Iran has tested the boundaries of the agreement through limited missile activity targeting U.S. naval assets, while the U.S. blockade continues to constrain Iran’s oil export capacity and broader economic activity. Reports suggest growing frustration within the Administration as Iran has yet to fully comply with negotiated terms, underscoring the fragile nature of the current détente and the ongoing risk of renewed escalation.

• Against this backdrop, economic data continues to reflect underlying resilience. U.S. GDP expanded at a 2.0% annualized rate last quarter – modestly below the 2.2% consensus estimate but a meaningful acceleration from the prior quarter’s 0.5% pace. However, inflation readings remain elevated with the most recent report being above expectations, driven in part by higher energy and transportation costs linked to the Middle East’s energy disruption. Increasingly, economists are questioning whether these pressures will prove more persistent, raising the risk of a renewed inflation cycle. Attention now shifts to upcoming labor market data, which will be critical in assessing whether employment conditions remain strong enough to overcome these headwinds.

Markets Shrug Off Geopolitical and Policy Uncertainty..

• The U.S.–Iran ceasefire was extended yesterday, though signals from Iranian leadership remain mixed. Iran’s ambassador to the United Nations indicated a willingness to pursue a more durable agreement, suggesting continued openness to diplomacy. In contrast, the Islamic Revolutionary Guard Corps struck a more confrontational tone stating that the U.S. naval blockade “is no different than bombing” and must be met with a military response. The U.S. administration has maintained its position, indicating the blockade will remain in place for now. The divergence in rhetoric underscores the fragility of the arrangement and the risk that tensions could re-escalate with limited warning.

• Meanwhile, Federal Reserve Chair nominee Kevin Warsh appeared before the Senate Banking Committee for his confirmation hearing. Lawmakers questioned him on his policy framework, financial background, and, most notably, his ability to maintain independence from the Executive Branch. The nomination process remains stalled as members of the Committee continue to withhold advancement pending the resolution of ongoing investigations involving current Chair Jerome Powell. The delay extends uncertainty around the future direction of monetary policy leadership at a time when inflation remains above target.

• Markets may receive additional clarity next week with the release of the March Personal Consumption Expenditures (PCE) Index. Expectations call for inflation in the upper-2% to 3% range – meaningfully above the Federal Reserve’s 2% objective and indicative of persistent price pressures. This backdrop complicates the interest rate policy outlook, particularly given the potential for continued energy-related volatility tied to Middle East developments.

• Despite disruptions in the Strait of Hormuz and the risk of broader instability in global energy markets, U.S. equities have continued to advance with major indices reaching new all-time highs. The divergence suggests investors remain focused on forward-looking expectations and the prospect of eventual stabilization, even as near-term geopolitical risks remain elevated.

Fragile Ceasefire, Firm Economy – so far…

• After a day marked by escalating rhetoric—most notably threats via social media that the United States would “end civilization” in Iran absent an agreement—President Trump announced late Tuesday that a two-week ceasefire had been reached. As part of the arrangement, Iran agreed to reopen the Strait of Hormuz, albeit with control over vessel traffic. Markets responded with equities strongly rallying, oil prices declining sharply, and U.S. Treasury yields moving lower. Even so, the durability of the agreement remains highly uncertain, with meaningful questions around both compliance and longevity.

• That uncertainty surfaced almost immediately. Within a day of the announcement, reports indicate renewed Iranian attacks on regional partners including infrastructure targets in Kuwait and additional strikes in the U.A.E. Complicating matters further, Israel—America’s primary regional ally—was not involved in the negotiations and has expressed strong dissatisfaction with the terms. While vessel traffic through the Strait appears to be gradually increasing, the broader backdrop reflects a fragile equilibrium where intermittent conflict coexists with efforts to preserve the flow of critical global trade.

• Against this geopolitical backdrop, the U.S. economy continues to exhibit resilience. The March employment report materially exceeded expectations with 178,000 jobs added versus consensus estimates of 59,000. Meanwhile, the unemployment rate declined to 4.3% from 4.4% in February. Attention now turns to the Federal Reserve’s preferred inflation gauge, the PCE Index, due to be released later this week. Current expectations call for a 2.8% year-over-year increase, implying little to no month-over-month acceleration. Together, labor and inflation data will remain central to the Fed’s policy path as it navigates an increasingly uncertain global environment.

Both financial markets and the global economy confront a narrowing path due to Iranian war energy disruption…

• Fighting in the Middle East continues to escalate with Iranian forces launching attacks on Kuwait, Bahrain, and Saudi Arabia. The U.S. administration has increased efforts aimed to de-escalate the war with officials suggesting that recent discussions with Iran have been constructive. The President has directed the Pentagon to delay any major military response to allow for potential progress. Iranian leadership, however, has disputed American claims, maintaining that no direct negotiations with the United States have occurred. The divergence in messaging underscores the uncertainty surrounding any near-term conflict resolution.

• A meaningful portion of global oil supply, estimated at ~15 million barrels/day, remains stranded in the Persian Gulf due Iran’s control of the Strait of Hormuz, a critical chokepoint for energy flows. Recent reports indicate an almost complete stop in non-Iranian tanker traffic through the Strait as risks—including sea mines, drone strikes, and small-boat attacks—have sharply risen. The result is a sharp tightening in global energy supplies driving oil prices higher and prompting some nations to draw on strategic reserves or take emergency measures. Iran is willing to utilize its control of the Strait in an attempt to outlast the American and Israeli offensive.

• Against this backdrop, the Federal Reserve held its policy rate steady at last week’s meeting. However, rising energy prices are beginning to filter through to broader inflation measures, complicating an already incomplete disinflation process. With inflation still meaningfully above the Fed’s 2% target, a sustained increase in oil prices could further constrain policy flexibility and delay any interest rate easing cycle. The risk of a stagflationary environment—characterized by stagnant growth and persistent inflation—is increasing, presenting a challenging backdrop for both policymakers and markets.

Energy Tensions and Conflicting Economic Signals Cloud the Near-Term Outlook…

• Rising geopolitical tensions in the Middle East have introduced a new source of volatility across global financial markets. The primary concern centers on the Strait of Hormuz, one of the world’s most critical energy transit corridors. Iran’s threats to target commercial vessels moving through the passage has created a temporary choke point in global oil and commodity flows. Given the region’s central role in global energy distribution, this development has been enough to push energy markets sharply higher in the last 10 days and inject additional uncertainty into equities, currencies, and other asset classes.

• While such developments naturally evoke comparisons to the oil shocks of the 1970s, the U.S. economy today is structurally far less vulnerable to energy supply disruptions. Energy production now represents a smaller share of domestic economic activity, and the United States has transitioned from being a net oil importer to a net oil exporter. These structural changes provide a meaningful degree of economic insulation relative to prior decades. Even so, sustained increases in energy and commodity prices could still work their way through the economy via higher input costs and renewed pressure on consumer prices—an outcome that would complicate the current inflation trajectory.

• Against this backdrop, the Federal Reserve faces a policy environment that is becoming increasingly difficult to interpret. The two variables most central to the Fed’s decision-making—employment and inflation—are currently moving in opposite directions. February’s labor report showed an unexpected decline of roughly 92,000 jobs, contrasting with expectations for modest job growth. At the same time, inflation data released today showed headline CPI rising 2.4% year-over-year and core CPI at 2.5%, broadly in line with expectations. Markets will receive another key data point later this week with the release of the Personal Consumption Expenditures (PCE) index, which will likely play an important role in shaping the Federal Reserve’s tone when policymakers meet next week.

Tariff Escalation, Slowing Growth, and a Higher Risk Backdrop…

• Last Friday, in a 6–3 decision, the U.S. Supreme Court ruled that the Trump Administration had exceeded its authority in imposing certain tariffs on key trading partners. The decision drew immediate criticism from the president who responded swiftly. Citing the Trade Act of 1974, the Administration announced a new 15% global tariff on all goods entering the United States, effective immediately. The rapid policy shift injected renewed volatility into the financial markets as investors reassessed expectations for retaliatory actions, supply-chain disruptions, and margin pressure across import-dependent industries.

• The U.S. Bureau of Economic Analysis also released its advance estimate for fourth-quarter GDP which showed that the economy expanded at a 1.4% annualized rate in Q4 2025. This growth rate was well below the 2.5% consensus forecast and sharply slower than the third quarter’s 4.4% pace. If sustained, full-year growth of 2.2% would mark a step down from 2024’s 2.8% expansion and would be the slowest annual growth since 2022. The data reinforced a pattern of uneven growth, with momentum fading into year-end. This report occurred against a backdrop of tightening financial conditions and policy uncertainty – the economy could in fact be decelerating rather than reaccelerating.

• Last week’s Inflation data added further complexity to the economic picture. The Federal Reserve’s preferred measure, the PCE Index, showed headline inflation at 2.9% year over year and the core rate increasing at a 3.0% rate for December 2025. However, the monthly figures were firmer with core prices rising 0.4%, a pace that—if it persists—could stall further disinflation. While recent CPI readings have been closer to 2.4%, policymakers place greater weight on PCE. Combined with a fading AI-driven equity rally and emerging stress in private credit markets, the macro backdrop is shifting toward greater caution and capital discipline rather than momentum-driven risk taking.

The Labor Market Stabilizes as Inflation Remains in Focus…

• Yesterday, the Bureau of Labor Statistics reported January job growth of 130,000, materially above expectations, while unemployment declined to 4.3%. Hiring remained concentrated in healthcare, continuing a narrow but durable trend that has supported overall payroll expansion throughout 2025. While breadth remains limited, the report suggests stabilization rather than deterioration in labor conditions. From a policy standpoint, a steady unemployment rate and moderate job creation reduce immediate pressure on the Federal Reserve to accelerate easing. With this release expectations for the next rate cut shifted out to the July timeframe.

• Attention now turns to the January CPI release where the consensus anticipates headline and core inflation moderating to 2.5% year over year. Such a reading would signal incremental progress toward price stability but still leave inflation modestly above the Fed’s long-term target. In this environment, policy is likely to remain data dependent. An in-line report would confirm the current rate path while any upside surprise could challenge elevated equity valuations and cause a re-evaluation of near-term rate easing expectations.

• Finally, the January-end nomination of Kevin Warsh to succeed Jerome Powell adds meaningful uncertainty to Fed’s outlook. Although confirmation appears likely, Warsh is generally viewed as supportive of lower policy rates, continued balance sheet reduction, and a stronger dollar. However, the possibility that Powell remains on the Board beyond his chairmanship could complicate leadership dynamics. For investors, the practical implication remains unchanged: maintaining disciplined portfolios, emphasizing higher quality balance sheets, and avoiding positioning portfolios to bet on sharp shifts in monetary leadership. The coming months could prove quite interesting for monetary policy, at a minimum.

Rate cuts on Hold Amid Persistent Inflation and Slowing Consumer Momentum…

• Chair Powell and the Federal Open Market Committee announced today that they will hold the federal funds rate unchanged, marking the first policy pause since September. The decision follows three consecutive rate cuts, including December’s decrease, which revealed growing internal resistance. Two Fed governors, both appointed by President Trump, dissented against the decision and favored an additional quarter-point rate reduction.

• Going forward, the key question is when to resume cuts. The answer lies on which peril appears first, a weakening job market or inflation that convincingly resumes falling towards the Fed’s 2.0% percent target. While job growth has slowed sharply, unemployment has stabilized at around 4.4%. Meanwhile the clarity of recent inflation readings have been disrupted by the fall government shutdown. The committee is likely to require clearer evidence of economic deterioration to achieve a stronger consensus before resuming the interest rate easing cycle.

• Last week, the Fed’s preferred inflation gauge, the Personal Consumption Expenditures (PCE) Index, was belatedly released covering the combined period of October and November. The reading came in modestly above expectations with both headline and core inflation registering at 2.8% year-over-year versus consensus estimates of 2.7%. Markets showed little reaction, reflecting both the marginal nature of the upside surprise and the increasingly dated nature of the report. Attention now turns to the December PCE release, expected late next month, and which should provide a clearer assessment of inflation trends.

• Despite equity markets reaching record highs and economic growth accelerating, the Conference Board’s January consumer confidence survey had its lowest reading since 2014. Respondents cited persistent price pressures in everyday necessities such as groceries and gasoline, alongside ongoing uncertainty surrounding trade policy and labor-market conditions. Notwithstanding commentary from the Administration, many Americans are feeling financially stretched.

• Meanwhile, earnings season is now well underway with more than 65 S&P 500 companies having reported with ~75% having delivered earnings per share above analysts’ expectations, and broadly in line with historical averages. The quarter’s earnings growth rate stands at 8.2%, largely unchanged from initial estimates. If this trend continues, it would mark the tenth consecutive quarter of year-over-year earnings expansion and underscoring the resilience of corporate profitability despite tighter financial conditions and slowing economic momentum.