U.S. stocks had a strong week on the belief that a resolution to the conflict in Iran might be near. But it’s the impact of the war that’s becoming the bigger story. We’re beginning to see sharp increases in inflation on both the consumer and business sides. With the negotiated ceasefire in Iran looking more fragile by the day, market anxiety remains high.
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Market Moves
Weekly Market Snapshot:
- S&P 500: +3.6% – stocks enjoyed a relief rally on the ceasefire agreement in Iran, but still remain a risky proposition as inflation rates are starting to soar.
- Nasdaq 100: +4.4% – this past week had a definite risk-on feel to it as tech and growth stocks returned to provide leadership.
- Russell 2000: +4.0% – stocks moved broadly higher, but the higher sensitivity of small-caps to current economic and political risks remains a concern.
- VIX: 19.3 – market volatility dropped to its lowest level in 7 weeks as the Iran ceasefire helped stabilize both stocks and bonds.
- Gold: +1.8% – precious metals continued moving higher as lower interest rates and a weaker dollar provided a boost.
- 10-Year Treasury Yield: 4.32% – interest rates showed signs of evening out, but the sharp increase in inflation runs the risk of pushing them higher again.
Drivers:
On one hand, investors enjoyed at least some temporary relief from the Iran conflict. On the other hand, damage to the global economy is already being done. Inflation in the U.S. jumped to its highest level in two years while corporations have indicated a slowdown in activity due to rising input costs. Even though the U.S. economy is still in relatively good shape and corporate earnings growth is strong, the Iran war is going to drive financial market performance for the foreseeable future.
Economic Highlights
A couple of the notable themes that stood out this week:
The non-Ceasefire Ceasefire
The markets staged a huge relief rally after a last minute 2-week ceasefire was announced following President Trump’s threat that a “whole civilization will die“.
Stocks prices took off, bonds rallied, and oil prices dove. Brent crude is back to trading below $100/barrel and seems to be holding that level. But Israel’s subsequent attack on Lebanon and Iran’s targeting of the East-West pipeline strongly suggest that this isn’t a firm ceasefire likely to hold up. And the Strait of Hormuz is still effectively closed.
Source: Barchart.
The markets may have rallied on optimism, but the post-ceasefire events demonstrate that not a lot has changed. Energy prices are likely to remain high. Inflation rates should be expected to keep trending upward. Corporate activity is probably going to show signs of slowing down. All of these are direct impacts of the conflict.
Until a detailed ceasefire agreement is formally agreed to and followed by all parties involved, the markets are unlikely to keep any rally sustained.
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Iran War Triggers Huge Inflation Surge
The March inflation report was going to be among the first to detail the tangible impact of the unrest in the Middle East. And it delivered as expected.
The consumer price index (CPI) rose by 0.9% month-over-month, the biggest one-month jump since June 2022. The annualized rate climbed all the way to 3.3%, its highest level in nearly two years. Given that the core inflation rate jumped only 0.2%, this increase in prices was almost entirely attributable to rising energy prices.1
Source: Bureau of Labor Statistics.
Sticky inflation has been an ongoing issue even in the aftermath of the COVID recession. Rate cuts already seemed unlikely this year even before what’s happened in the Middle East. This CPI report could make it almost impossible for the Fed to lower rates, although it still appears to be on the radar for 2026.2
More importantly, this raises the chances that the U.S. economy gets stuck in a stagflationary spiral, one of the worst possible environments. The combination of low growth and high inflation makes it challenging for the Fed to provide much help and could take years to pull out of.
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Inflationary Pressures Start to Slow Business Activity
On the surface, the ISM Services PMI report for March looks positive. The reading of 54 marks the 21st consecutive month this sector of the economy has been expanding.3 Beneath the surface, however, there are some causes for concern.
Source: Institute for Supply Management.
The business activity and employment sub-components of the report showed significant declines. The price index also rose to its highest level since October 2022, reflecting the higher costs of fuel and shipping.
The slowing down in hiring is something that we’ve been watching in the entire economy for months. It sounds repetitive to say it at this point, but higher prices and slower business activity are the result of events in the Middle East. Giving it a positive spin, geopolitical events tend to be shorter-term in nature and the Iran war could end at any time. When that happens, conditions should return to their pre-war state relatively quickly, although the lag of damage already done could take time.
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U.S. Consumer Sentiment Hits Lowest Level in More Than 70 Years
The University of Michigan’s index of consumer sentiment continue to dive to lows the report has never seen. In March, the index hit an all-time low of 47.6, beating the previous record from mid-2022.4 This report was first launched in 1946.
Source: YCharts, University of Michigan.
Consumer spending levels continue to hold up, but confidence in households’ employment situation and optimism about the economic environment in general show that it may not be able to hold up much longer. The K-shaped economy suggests that most of the pain continues to be experienced by lower earners.
The Week Ahead
A few themes to watch next week:
In Summary
Despite this week’s rally in equities, a large cloud of uncertainty remains. We still have an unclear path and timeline for the war in Iran. The U.S. economy is holding up for now, but soaring inflation rates in March show that the damage is only now being felt. Corporate earnings will try to reassume the spotlight next week and that should be a positive for the markets. But expect volatility to continue even though it subsided this week.
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