News of a Middle East ceasefire briefly boosted risk assets, yet Wall Street strategists warn the conflict has inflicted wounds on inflation, energy supply, and the Federal Reserve's policy flexibility that will not heal quickly. This week, major U.S. stock benchmarks rose broadly, with the S&P 500 index posting a significant 3.6% weekly gain, its largest since late November last year.
However, the rally showed signs of fatigue on Friday afternoon, with the S&P closing lower amid market concerns over whether weekend peace talks could end a six-week war that has deeply impacted the global economy.
This turmoil has forced Wall Street strategists to reassess their optimistic forecasts from the start of the year. An oil price shock has driven the largest monthly inflation increase since 2022, consumer confidence has plunged to historic lows, and traders' expectations for Federal Reserve rate cuts this year have nearly vanished.
Strategists are broadly raising their inflation forecasts and pushing back their projected timelines for interest rate cuts.
Multiple strategists indicated they had not initially factored the Middle East conflict into their base-case 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, acknowledged:
We did not anticipate a Middle East conflict at the start of the year, nor did we foresee national U.S. gasoline prices surging above $4 per gallon.
He expects year-over-year inflation could approach 4% this summer, significantly delaying the timeline for the Fed to return to a neutral interest rate (around 3%). Nevertheless, he remains relatively optimistic, believing inflationary pressures are mostly driven by temporary factors. He anticipates inflation could fall below 2% next year, potentially allowing the Fed to implement one or two rate cuts. Alexandra Wilson-Elizondo, Global Co-Head of Asset Management at Goldman Sachs, 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 sole mandate of price stability, might conversely be forced to raise rates. Ann Miletti, Head of Equity Investments at Allspring Global Investments, who initially forecast two Fed rate cuts this year, has now postponed one of those cuts 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.
Divergence in risk assets intensifies, 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 the fixed income space. 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 re-engage in fixed income, particularly in the U.S.
She also warned that corporate credit faces pressure for more risk repricing, stating, "the credit cycle appears to be turning." Last month, the BlackRock Investment Institute shifted 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 long-term rates will continue to rise. Julian Emanuel, Chief Equity and Quantitative Strategist at Evercore ISI, is relatively more optimistic, citing robust earnings and manageable bond yields as supporting factors. However, he highlighted oil prices as a key variable. He said:
If WTI crude can remain consistently below $90 for the rest of the year, equities should be able to perform well.
A mix of maintained and lowered price targets among institutions.
Most institutions are currently 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, stated that his team, influenced by Tuesday's ceasefire news, paused actions they were considering regarding portfolio adjustments. They currently forecast 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 expects one rate cut each from the Fed and the Bank of England, with the European Central Bank holding steady. Scott Chronert, U.S. Equity Strategist at Citi Group, maintains the optimistic forecast he issued in mid-December, citing that "much of what we are seeing appears transitional." However, he concurrently 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-era tariff policies. He noted 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. Chief Equity Strategist Ohsung Kwon 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 deterioration driven by earnings, we still expect solid equity performance for the full year.
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