News of a ceasefire in the Middle East briefly boosted risk assets, but Wall Street strategists warn that the conflict has inflicted wounds on inflation, energy supply, and the Federal Reserve's policy flexibility that will not heal quickly. This week, major US stock benchmarks broadly advanced, with the S&P 500 posting a cumulative surge of 3.6%, marking its largest weekly gain since late November of last year. However, the rally showed signs of fatigue on Friday afternoon, with the index closing lower as markets grew concerned about whether weekend peace talks could end a six-week war that has deeply impacted the economy.
This turbulence has forced Wall Street strategists to reassess their optimistic forecasts made at the start of the year. An oil price shock has driven the largest monthly increase in inflation since 2022, consumer confidence has plummeted to historic lows, and traders' expectations for Federal Reserve rate cuts this year have nearly vanished. Strategists have widely revised their inflation expectations upward and pushed back their projected timelines for interest rate cuts.
Many strategists indicated that they had not initially factored the Middle East conflict into their baseline scenarios and are now conducting stress tests on their price targets and interest rate paths. David Kelly, Chief Global Strategist at J.P. Morgan Asset Management, admitted, "We did not anticipate a Middle East conflict at the start of the year, nor did we expect national gasoline prices to surge above $4 per gallon." He anticipates that year-over-year inflation could approach 4% this summer, significantly delaying the timeline for the Fed to return to a neutral interest rate, estimated around 3%. However, he remains relatively optimistic, believing the inflationary pressures are largely due to temporary factors. He expects inflation could fall below 2% next year, potentially allowing the Fed to implement one or two rate cuts then.
Alexandra Wilson-Elizondo, Co-Head of Global Portfolio Management at Goldman Sachs Asset Management, expects the Fed to maintain a clear "on hold" stance until the direction of growth and inflation becomes clearer, though she still anticipates one rate cut this year. She also noted that the European Central Bank, with its singular mandate of price stability, might conversely be forced to raise rates.
Ann Miletti, Head of Equities at Allspring Global Investments, who initially forecast two Fed rate cuts this year, has now pushed one of those cuts out to 2027. She stated, "The slowdown in growth has been more pronounced than we expected, and the upward momentum in inflation has also been stronger than anticipated."
Divergences in risk assets are intensifying, with fixed income and credit markets attracting attention. As short-term U.S. Treasury yields have risen, some strategists are beginning to find opportunities in fixed income. Wilson-Elizondo pointed out that the two-year Treasury yield has risen nearly 50 basis points since the war began to around 3.8%, saying, "The market has created an opportunity for us to reposition in fixed income, particularly in the U.S." She also warned that corporate credit faces pressure for more risk repricing, noting that "the credit cycle appears to be turning."
BlackRock Investment Institute last month adjusted its allocation to risk assets from overweight to neutral. Jean Boivin, Head of the Institute, said, "We may return to a preference for risk assets, or we may conclude that the damage from supply shocks and stagflation will dominate the path ahead." BlackRock maintains an underweight position in long-term U.S. Treasuries, favoring European bonds instead, anticipating that long-term rates will continue to rise.
Julian Emanuel, Senior Managing Director of Evercore ISI's Equity, Derivatives & Quantitative Strategy team, remains relatively optimistic, citing robust earnings and manageable bond yields as supporting factors. However, he identified oil prices as a critical variable. He stated, "If WTI crude can remain consistently below $90 for the rest of the year, the stock market should be able to perform well."
Currently, most institutions are choosing to maintain their full-year price targets for now, but their reasoning and conviction levels vary. Luca Paolini, Chief Strategist at Pictet Asset Management, said that influenced by Tuesday's ceasefire news, teams that were close to adjusting their portfolios have paused action. Pictet currently expects the S&P 500 to end the year at 7250, European equities to gain about 10%, and the 10-year U.S. Treasury yield to fall below 4.25%. Pictet anticipates one rate cut each from the Fed and the Bank of England, with the ECB holding steady.
Scott Chronert, US Equity Strategist at Citigroup, is maintaining the optimistic forecast he issued in mid-December, reasoning that "much of what we are seeing appears transitional." However, he acknowledged that risks cannot be ignored, including persistently high oil prices keeping interest rates elevated for longer, pressure on the private credit market, and potential disruptions from AI impacts and Trump's tariff policies. He pointed out that earnings estimate revisions are concentrated in a few large-cap stocks like NVIDIA and Broadcom, and the process of market rotation has clearly stalled. He said, "This is a market still searching for direction; it's too early to make definitive judgments."
Wells Fargo is one of the few institutions that has lowered its full-year forecast, reducing its S&P 500 target from 7800 to 7300. Ohsung Kwon, Chief Equity Strategist at Wells Fargo Securities, believes the current economy is less sensitive to oil prices than in past cycles, and tax refunds will partially offset consumer spending pressures. However, Kwon stated, "Unless we see clear earnings-driven deterioration, we still expect the stock market to deliver solid performance for the full year."
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