Stock and Bond Markets Shrug Off Mideast Conflict and Inflation Risk

Jeff Buchbinder (00:00):

Hello everyone and welcome to LPL Market Signals. Jeff Buchbinder here with my friend and colleague Lawrence Gillum. Lawrence, we of course, have to talk about the Mid East because that is certainly what everyone's focused on, market watchers and otherwise, but we also have extreme heat going on in the United States. How are you holding up amid, I guess, heat indexes near a hundred degrees, both where you are and where I am?

Lawrence Gillum (00:30):

Yeah, it's we're doing well. We're trying to stay inside as much as possible, though. If you don't have to be outside, don't go outside.

Jeff Buchbinder (00:39):

Amen to that. The kids are home from school, so I cannot promise there will be no disruptions during the next half hour that we're talking to you. But hopefully the internet holds up in this extreme heat. So everybody stay cool, stay hydrated. And I agree with you, Lawrence. Let's not go outside too much. So here's our agenda. Of course, we're going to talk about the Middle East and the goings on, which, I mean, it's minute by minute. The market recap last week, though is worth discussing beyond the Middle East, because there was more than that. Certainly we had a Fed meeting. So I'm glad Lawrence, you're with me to help me dissect the Fed. We will also talk about the Weekly Market Commentary, which is on the different markets in China. The A-share market and the H-share market have been acting very differently.

Jeff Buchbinder (01:32):

So our head of macro strategy, Kristian Kerr wrote about that. We got a couple charts to highlight his key points. And then of course, as always, we will end with a preview of the week ahead. And I think the core PCE inflation data is probably the biggest data point on the calendar. All right, let's start with the market recap here. This is a five day look. Of course, we had a holiday shortened week last week. The holiday shortened week, actually, the market was, was pretty much flat. But on the five day, the S&P down 1.2%, that was the start of the Israel-Iran slide the prior Friday. We haven't really seen a change in leadership in terms of, you know, large cap relative to small cap. Small cap continues to struggle. International, you know, it's done very, very well this year.

Jeff Buchbinder (02:26):

But actually, the outperformance has waned a little bit as U.S. tech has done a little bit better lately. And certainly U.S. energy has done better lately. You see here from the sector performance, it's really energy sector up and pretty much everything else down that is reversing today. The latest headline as we're recording this, it's Monday right after lunchtime here in on the East Coast, June 23, 2025. The latest headline is that Qatar intercepted a missile fired by Iran at a U.S. military base. So actually that is sending oil lower because the market is thinking that maybe Iran won't target the Strait of Hormuz. Clearly, there was some possibility of closure to the Strait, which is where about 20% of global oil flows. In fact, on Polymarket, one of the you know, the sites where you can see odds of things happening, the odds of a closure to the Strait of Hormuz were 48% late this morning. So that is a very meaningful probability. Doesn't tie one to one to the market necessarily, but is a very meaningful probability of a closure. So I think the market actually prefers this form of retaliation and is taking oil down accordingly. So bond market, of course, Lawrence, the Fed influenced here. But I mean, it also looks like the market's comfortable with the inflation picture as well.

Lawrence Gillum (04:01):

Yeah, that's right. So it was a pretty good week last week for fixed income markets. The aggregate bond index up about 30 basis points, perhaps quietly up 3% on the year, on pace for a coupon plus type year if things continue along the path it's headed currently. A lot of the activity came on Friday after one of the Fed officials, Governor Waller, Chris Waller, talked about the potential for a July rate cut. We've heard more about that today from another Fed official. So maybe there's a growing probability or a possibility anyway of a earlier Fed rate cut than it was priced in, that should be supportive for the bond market, if that trend continues. But all in all, pretty good week. Most sectors in the positive on the week. And you know, quietly, again, having a relatively decent year for fixed income.

Jeff Buchbinder (04:59):

Yeah, absolutely. Just as good as stocks and stocks have had a decent year at this point. You know, getting back into the green. It's also encouraging that the market didn't price in the rise in oil into yields, right? So even as oil prices were moving higher yields behaved. So that to me is certainly a good sign. And it looks like that trend is continuing now into the new week after, of course, the news that the U.S. got involved although in a very targeted way, just going after nuclear capabilities based on everything we're hearing out of the Trump administration, you've all heard this by now. They do not expect any sort of wider conflict or broader U.S. involvement in any way. So and let's hope that's the case. So that's that.

Jeff Buchbinder (05:51):

Here's your S& 500 chart, and you see here we've rolled over just a little bit. As we're recording this, we were kind of flat-ish last check. Yeah, S&P 500 is flat. So you know, on the one hand we're range bound going back maybe six, seven months. But then on the other hand, we are above these moving averages, and the moving average lines are actually still pointing higher. So this is still a decent technical picture. We still have about half of the S&P 500 above, its 200-day moving average, but we are very close to breaking some of these moving averages. So, you know, we've been talking about maybe 57 to 5,800 as an area of support if we dip. And then below that you're talking about maybe 5,500. We'll have to wait and see. But for now, this picture looks just fine.

Jeff Buchbinder (06:50):

So last week we included this table of how the stock market's done during geopolitical shock events. So I just want to bring this out again for anybody who missed it, just to see the numbers and reiterate the message, which I think has been pretty clear over the last few days as the market has remained resilient. Typically these shocks, if they are contained, and if they don't result in sustained economic weakness, then the market shrugs them off. They typically just last maybe a few weeks, if that. Some of them are a day or two, typically last a few weeks. And then the market starts to recover. And you can go down, bottom, back up and make a new high within, or at least recover to the pre-shock levels within about six weeks, typically. So hopefully this won't be six weeks. Hopefully the market will make a new high and recover these recent losses.

Jeff Buchbinder (07:46):

They're very minimal. Hopefully we'll recover those recent losses even faster. This is a blog that we did on lpl.com under the Research tab. I believe it was a week ago. So Monday. So take a look at that. By the way, there's another way to look at this and it's to just look at U.S. military strikes. The message is very much the same though if you just isolate U.S. military involvement, because these are all sorts of events, right? The average performance for the S&P 500 six months after is 7%. And you've got a very high batting average. Again, same message, if you're not in recession, you're going to do just fine. This look gives you basically the same number, median six months later, 7%. So we think this is going to be another one just like most of these, and not something like 911 or the first Gulf War, which happened during an economic challenging economic period or anything in the mid-70s. So, positive message for folks who are nervous. Alright, let's move on and talk about the bond market, Lawrence, which is why you're here recapping the Fed meeting. Certainly, I'm glad you brought up the fact that we've had some very dovish comments out of a couple of Fed officials over the last few days because that has certainly moved the bond market. But tell folks what we heard from the Fed and what it means for bonds going forward.

Lawrence Gillum (09:19):

Yep. So as we know the Fed and the fed funds rates are all highly correlated to what we see out of the Treasury market. So as they talk about future rate cuts, that's going to have an impact on Treasury yields as well. This is just a 10-year Treasury yield. It seems like we're stuck in this range, 4% to 4.5%, which coincidentally is our new range. I don't know if I'm allowed to share this or not, but I'm going to anyway. Is our new range for the 10-year Treasury yield through year end, we're going to.

Jeff Buchbinder (09:48):

Not a hundred percent final, not a hundred percent final. We still have a chance to change it. How about that?

Lawrence Gillum (09:53):

Okay. So perhaps we'll change it but I think, you know, four to four point half percent is probably a good range to kind of set your expectation for throughout the rest of this year. Unless there's some sort of geopolitical event or an economic contraction, which on the latter we don't expect. But so I think we're kind of in these ranges for the foreseeable future. What could bring those levels down? The 10-year Treasury yield down, is if we start to see more rate cuts get priced into the market. So that dovetails into what we saw last week with the Federal Reserve. And if you want to move ahead a slide. Last week, I'll sum up last week's Fed meeting by kind of saying it was as expected for the most part no change to the fed funds target rate.

Lawrence Gillum (10:44):

We're still in that 4.25 to 4.50 range for the fed funds rate. So, the Fed is on hold apparently for the foreseeable future. But what was kind of slightly interesting last week is we did get an update on the Summary of Economic Projections. This is the Fed's forecast for growth to inflation, unemployment. But we also got a new updated dot plot, and that's what we're showing on the screen here. The dot plot is just the expectations of the individual members of where the fed funds rate will be over time. A lot of dots, a lot of lines. But if you look at the individual dots, those are the individual expectations by each respective Fed member. So 19 dots there and what was notable is that there wasn't a change to the number of cuts expected this year.

Lawrence Gillum (11:39):

I think there was an expectation at least, but for some in the fixed income markets that maybe the two cuts expected this year would get priced out, and maybe only one cut would be shown on this dot plot. The blue dots are the most recent dot plots. So those are the ones that we're really looking at now. But that didn't happen. So I think that was a sigh of relief out of the fixed income markets. You did see more Fed members change their view to say no cuts in 2025 which was notable. But market seemed to shrug that off a little bit and just kind of paid attention to that median dot there. There was a change on the out years to 2026.

Lawrence Gillum (12:26):

There was one cut taken out of the market pricing or market expectations, didn't really have a big impact on markets either. So we don't tend to see kind of the bond market in any way yawn during Fed Week. But I would say we got a yawn out of the bond market after the Fed meeting because it largely went as expected, which was good news. But what was interesting though is we're starting to get Fed speak again. So we're starting to hear the individual members of the Federal Reserve come out and talk about kind of how they view the fed funds rates and kind of how they view the economy going forward. And notable on Friday, and again, today, on Monday, we're starting to hear some Fed officials say, maybe we can cut in July, opposed to what was priced in in terms of September as a rate cut at the earliest. So we'll have to see how this plays out this week. There's a lot more Fed speak, but if that becomes the narrative we could see you know, a rally out of the fixed income markets.

Jeff Buchbinder (13:30):

Is there anything in here, Lawrence, that suggests maybe someone who's normally dovish is a little more hawkish or vice versa, or, you know, people say like, the tiger doesn't change it's stripes, it's kind of everybody falling in line to where you would expect they would be. Do you think?

Lawrence Gillum (13:48):

Well, the two Fed officials that came out recently, Governor Waller is kind of a noted dove. He's mm-hmm <affirmative>. He's probably at the very bottom of these dots. He's one that tends to champion cuts. He's been pretty right as of late, but he does kind of champion cuts. Today, Michelle Bowman, who is normally a very hawkish Fed speaker was the latest to say perhaps July. Remember back when the Fed cut 50 basis points. It was September of last year, she dissented because she didn't think 50 basis points was appropriate. She wanted 25 basis points. So she's interesting. I would argue probably on the other end of the spectrum from Governor Waller, where she tends to be a bit more hawkish. So her testimony is carrying a lot of weight this morning.

Jeff Buchbinder (14:45):

Very interesting. So, yeah. We'll be following this closely. But yeah, high level, I guess it doesn't really change. It's really when you dig in, maybe this is a little bit more dovish.

Lawrence Gillum (14:57):

Just to throw a little conspiracy theories out there, both of those individuals, Bowman and Waller, Trump appointees, so maybe they're listening to the Truth social posts and are trying to, you know, maybe vie for the next head of the Fed job, we'll say.

Jeff Buchbinder (15:18):

And political cover may be for Powell, who doesn't want to be seen as political. So, you know, if the rest of the FOMC leans toward cut, maybe he goes along for the ride. Sure. Wow. Interesting.

Lawrence Gillum (15:34):

Who says these Fed meetings are boring? It's like a soap opera.

Jeff Buchbinder (15:38):

There you go. Yeah. What are the latest odds on the next Fed Chair? I mean, I know Warsh is a name we've heard. I know

Lawrence Gillum (15:45):

Bessent is in there.

Jeff Buchbinder (15:46):

Secretary Treasury Bessent is a name we've heard.

Lawrence Gillum (15:50):

And yeah, I think it's still too soon to know definitively. Warsh is one of kind of the front runners. Bessent has been out there, Waller who's on the committee right now is a name that's popped up as of late probably because of his dovish view on rates. So mm-hmm <affirmative>. Bottom line is, well, the bottom line is Powell's going to be there until, I think it's May of next year. But after that the market. I think we'll start pricing in the probability of a perhaps more dovish Federal Reserve than what we have now, which, again, it should be supportive for the fixed income markets.

Jeff Buchbinder (16:26):

Right. But we'll probably get a name within the next one. Oh, sure, yeah. Yeah. We're going to get a name pretty soon. Okay. good, little tangent there. Let's go to your next chart. Certainly President Trump is trying to brand Powell as too late. Is that the key point here?

Lawrence Gillum (16:44):

It is. So right after the Fed meeting, of course, there was some name calling by the president about Jerome Powell being too late to cut rates. I think he said something like the chairman of the Fed Reserve, Jerome Powell, was costing the government, what was it, 600 billion or a trillion dollars a year in annual expenses. This is the topic of tomorrow's blog. So Tuesday's blog. But I looked in to see kind of what would the scenario be if the Fed did cut rates by 2% to be consistent with what Trump has argued. And really the only impact it would have on the interest expense is related to those orange, that orange part of the bar. Those are your Treasury bills. Those are the ones that mature in a year or less.

Lawrence Gillum (17:32):

Those are the ones that get priced off of or at least near what the fed funds rate is offering. So if the Fed did cut rates from 4.5% to 2.5%, debt service costs would come down a little bit. We're looking at, probably, given the current composition of the T-bill market, you're looking at about 125 billion to 150 billion in savings by that 2% cut. It's not chump change, but it's not the 600 billion that perhaps that Trump noted. But it would certainly help offset some of the ongoing interest expenses marginally, you know, you could argue because it's really going to only impact that T-bill market. The rest of the Treasury issuance. And that's what we're showing here, just the distribution of Treasury securities and it's kind of the maturity dates associated with these securities.

Lawrence Gillum (18:28):

Most of the bonds that the Treasury Department issues are longer maturity, so call it two years and out those have a fixed coupon. The weighted average coupon, as you can see on the screen, is about 2.85%. So in order to get real savings from, you know, refinancing debt as it comes due, we're going to need to see much lower yields across the entire Treasury yield curve, perhaps back to that zero interest rate policy that we saw pre-COVID, which we don't think we're going to get to anytime soon. So I think interest expense is going to be a challenge for the government on a go forward basis. You know, for the foreseeable future anyway,

Jeff Buchbinder (19:09):

I suspect for as long as we're doing Market Signals, we're going to be talking about how the U.S. has too much debt and the cost to finance that is a risk <laugh>. So,

Lawrence Gillum (19:17):

Which means I have a regular spot on the podcast, right?

Jeff Buchbinder (19:22):

Yes. Job security for you, absolutely. Because to be honest, I don't know how to do this chart in Bloomberg <laugh>. Well, I'm relying on you to bring it up for us <laugh>. So thanks for that, Lawrence. We have also talked about the percentage of interest relative to tax receipts for the federal government. That number is at last check around 17%, which is about as high as it ever gets. And I've learned this from you, Lawrence, and certainly our economist, Jeffrey Roach has talked about this. That is the point where you tend to see action. Mm-Hmm. Either spending cuts, tax increases, whatever, reforms we've seen reforms to entitlements before. Something like that's coming. It's just not coming right now. Certainly the tax bill, the reconciliation bill is not going to address that, but at some point we're going to have to we will be able to talk about that on many, many future <laugh> Market Signals podcasts. So let's, let's stay away from that. We got enough to talk about certainly we're not even talking that much about the Middle East and yet we're still going to easily hit a half hour. Alright, so next chart, another too late Powell chart. I mentioned it's good that the market is looking through the little bit of a bump up in oil prices and not pricing in a lot of extra inflation based on what the bond market's doing anyway. Is that the key point here, Lawrence?

Lawrence Gillum (20:48):

It is. And this is maybe an argument to suggest that Trump has a point and that because remember during the Fed meeting Powell noted that there's potential for increased inflationary pressures given the tariffs. Bond market doesn't think so. Bond market doesn't agree with that because these inflation expectations remain anchored. The bond market doesn't really see, or foretell anyway, a higher inflationary regime over the next couple quarters or years. What we're showing here are these break even yields. It's just the difference between Treasury Inflation-Protected Securities and nominal Treasury yields. That difference is the market's expectations for inflation over time. And the market is still pricing in inflation rates of about 2.3, 2.5%, which is kind of consistent with where we are or even potentially lower than where we are and by some measurements. So there is an argument that the Fed could be cutting rates because of the fact that the bond market really isn't overly concerned about inflation right now. So we'll see. I mean, maybe, you know, maybe after this next CPI print next month, maybe the Fed will get more comfortable with the potential for maybe less inflation than they were expected. And we can get these rate cuts started again. But this chart anyway suggests that maybe Trump has a point.

Jeff Buchbinder (22:17):

Yeah, the tariff driven inflation has been minimal thus far. Now, companies can draw down inventory that obviously did not face tariffs already. It's going to probably take another couple of months before we really start to see that in any meaningful way. But I think the Fed agrees we probably will see a little bit of effective tariff inflation at some point here fairly soon. But if it's modest, I could see the Fed cutting before inflation starts to head back down again.

Lawrence Gillum (22:45):

Yeah, I agree with that. So the next couple of months will be important to determine the trajectory of the fed funds rate for the rest of the year.

Jeff Buchbinder (22:56):

We've also got to look through the oil driven inflation as well, but with oil down, actually let me get an updated price because it moves wow, oil's down 5%, WTI and Brent. Mm-Hmm. This morning it was up one. So that's quite an aggressive move down as the market prices in a lower probability of a disruption to oils shipments through the Strait of Hormuz. We've been following the odds of that in the marketplace through Polymarket. It is now, actually, it's only down to like 40. So we've clipped 10 percent off of the odds according to this one market site, only taking 10% down. But I suspect there's more downside ahead if Iran doesn't close the Strait here in the next few days, they've already essentially voted in the Iranian parliament to do it.

Jeff Buchbinder (23:53):

They've threatened to do it not just this week, but many times before. So I mean, market's still pricing in a pretty meaningful chance of that happening. Let's hope not, because that's China's oil, right? They don't necessarily want to anger China too much, and that's really what they would do, even if they would inflict a little bit of pain on the U.S. and our allies. So let's turn to speaking of China, that was a great segue. If I do say so myself, we wrote the Weekly Market Commentary on China, the A-share market versus the H-share market. So I'll just go through this really quickly. The whoops, the A-share market has been range bound. It hasn't really been doing anything. So why is that? Well, the, A-share market is driven by local Chinese investors primarily. This is not what we would buy if we went and bought a Chinese ADR, that would be an H-share listed in Hong Kong.

Jeff Buchbinder (24:56):

Typical investor is buying the H-shares, local Chinese buying A. So A-shares have not done very well after the initial stimulus announcement last September. Essentially, the local Chinese have not seen a meaningful improvement in the economy, and therefore this market is actually trading well below where it popped when that stimulus announcement, the big stimulus announcement was announced back in September of last year, that's what this market's focused on. The H-share market looks much different. I'll just flip back and forth. Chart of A-shares chart of H-shares, very different. This is a bullish chart. This is a market that's held the 200-day moving average. The 200-day moving average is in an uptrend. We are above the highs of the September peak after the stimulus announcements. So why is this? What makes this market different? Well, as I mentioned, it's for global investors, for people like us, if we want to buy ADRs, we're going to buy the H-shares.

Jeff Buchbinder (26:08):

What has driven the strength in H-shares? Well, we had this big rotation out of the U.S. right? We had DeepSeek, the Chinese AI advancements, which caused U.S. tech to sell off and U.S. equity investments to roll into or rotate into international investments. So the H-share market got a lot of those assets. Some of them went into the A-share market through Chinese mutual funds, but a lot of it went into the H-share market, right? I think that's probably the biggest reason We also have a technical bullish picture here, right? Not only do you have, you know, a market that's held its 200-moving average, but you also have a broadening out recently beyond tech. So, you know, really this was about China AI and China tech initially that led the H-share market to perform

Jeff Buchbinder (27:07):

so well, now we're seeing a broadening that is certainly a positive story. And then we've also been watching inflows and they've been quite strong. So as long as those inflows remain healthy, and a lot of this coming from U.S. investors, as long as those inflows are healthy into this market, then we think this market actually can continue to move higher. So this is potentially a durable picture. So, LPR Research did increase its rating in emerging market equities about six, seven weeks ago. Part of the reason was technical because we're seeing good charts, we're seeing good inflows, we're seeing a rotation that is an environment where you want to be more diversified. So all that more covered in the Weekly Market Commentary written by Kristian Kerr, head of macro strategy, a really interesting dichotomy, we'll call it, between these two different markets within China with a very different set of investor bases.

Jeff Buchbinder (28:08):

So that is that you can find that on lpl.com under the Research tab, and you can also find Lawrence's blog that he just referenced there as well, and actually these podcasts, Market Signals. So, all right, that's that. Let's preview the week ahead, Lawrence, or obviously feel free to add anything on China that you want. Obviously we're going to have to watch the headlines on Iran. I mean, we just had one headline literally hit minutes ago that drove oil prices down about 5% <laugh>. So that tells you how fluid this situation is. We certainly aren't going to try to predict where this goes next, but what we will predict, or I'll say that the odds that Iran tries to close the Strait of Hormuz are very, very low. Some may be minor disruptions are possible, but odds they actually close it very low, and that would drive more U.S. involvement and a wider conflict. And clearly the market won't like that. That's when you get a $100 oil. Hopefully that does not happen. And it doesn't look like the market is worried about it right now. So, beyond watching the goings on in the Middle East, what else should investors be paying attention to this week, Lawrence?

Lawrence Gillum (29:22):

Yep. So heavy calendar, heavy economic calendar, PCE on Friday is probably the one that will be the most market moving, although when you have PPI and CPI data, you can really come up with your PCE estimate. So unless there's a kind of a big miss either way in either direction on the inflationary front it'll probably still be Iran and oil prices. Couple things that aren't on the calendar that are worth paying attention to. I mentioned earlier a lot of Fed speak and Jerome Powell is going to be testifying in front of Congress this week. So Tuesday and Wednesday, I think tomorrow he testifies in front of the House. Wednesday is Senate. So we'll see how that goes and if there's been any sort of change in his perspective on earlier rate cuts, like perhaps some of the other Fed officials out there. And then, you know, as a fixed income person, we're always watching the auctions. We've got about $180 billion of auctions this week, and kind of the two year, five year, seven year tenors. So given the, the amount of supply still coming to market, those will be interesting to watch, to see if demand is sufficient enough to take down all that supply. So I this week, maybe a kind of a non-economic week for markets. We'll have to see how the data unfolds though.

Jeff Buchbinder (30:46):

Yeah, that inflation number, I mean, if it ticks higher a little bit, it is in line with consensus. It's probably not going to move markets too much. This number, you know, May PCE is still a little early to see tariff impacts, although we may see a little bit we'll have to see. Actually. I think the most interesting data point on inflation we're going to get is Nike's earnings on Thursday. You might actually get a little bit from FedEx Tuesday night as well. But Nike's, I think, the most interesting one, company reporting this week. They're on a May quarter. And so we're going to get kind of a more recent, more timely look at how a retailer is handling inflation. We'll see, I've been doing kind of my own little surveys. So I went to a car dealership. They're eating the prices, the tariffs.

Jeff Buchbinder (31:34):

I upgraded my iPhone. They're eating the prices. They're not doing anything yet. Although they anticipate higher prices, I think we've heard that from Tim Cook. And then of course, going to the grocery store we're not really seeing too much incremental, at least I'm not based on what has happened over the last couple of months. So we'll keep watching that. I think we all need to make frequent trips to Chipotle and watch those avocado prices. Because that's a big one coming out of Mexico, I think 80% of our avocados are imported, something like that. Clearly eggs have been a problem, so we'll keep watching prices, but at this point, market is telling us that this is no big deal, the tariffs or frankly the risk to oil prices. We don't know if that's going to continue, but we certainly hope it does, for now

Jeff Buchbinder (32:22):

we will take it. The only other point I'll mention this week, the consumer confidence data that's been really interesting that has ticked up lately. And so hopefully that continues. We see pickups in consumer confidence in addition to, of course manageable expectations for inflation. Get both the conference board and the University of Michigan confidence this week. So a lot to watch needless to say. So with that we'll wrap. Thank you so much, Lawrence, for joining this week. I'm glad that you recapped the Fed because I would've really struggled to try to do that myself. Certainly got a little bit of Mid East. If there's anything else you guys want to want to know about our thoughts on the Middle East, certainly continue to follow our blog on lpl.com and I'm sure we will continue to write much, much more on that topic in the weeks ahead. So, with that, again, stay cool. It's going to be hot, lots of water and stay inside like Lawrence is going to do with the air conditioning running. Everybody have a great week and we will talk to you next time on LPL Market Signals. <Silence>.