Wall Street reacts to Middle East tensions as Fed rate decision looms
US stocks fell sharply on Friday as Iran retaliated against Israel with missile strikes, while traders now focus on this week’s Fed rate decision amid geopolitical uncertainty. The US 500 futures suggest recovery as Israel’s strategic strikes show early success.
US stocks retreat on geopolitical tensions
United States (US) stocks closed sharply lower on Friday as risk appetite evaporated after Iran retaliated against Israel’s initial attack with missile and drone strikes. For the week, the Wall Street slipped 1.32%, the US Tech 100 (Nasdaq 100) fell 0.60%, and the US 500 (S&P 500) lost 0.39%.
While the situation in the Middle East remains fluid, US US 500 equity futures are trading about 0.95% higher this morning at 6036, likely buoyed by Israel’s early success in its counter-strikes targeting Iran’s nuclear facilities, air defences, missile production, and military leaders to cripple strategic capabilities. Additionally, while Israel has targeted Iranian energy infrastructure used domestically in its response, it has refrained from targeting key Iranian oil export infrastructure.
Oil supply concerns add market complexity
Iran only produces about 3.5% of the global oil supply. However, there are fears that Iran may close the Strait of Hormuz in response to Israel’s strikes, which would impact oil trade, as it is the primary route for oil exports from major OPEC producers like Saudi Arabia, Iraq, the UAE, and Kuwait. This is viewed as a measure of last resort by Iran, as it would affect its main customers, China and India, and increase the likelihood of US military intervention.
The knock-on impact of higher energy prices is that they will slow growth and cause headline inflation to rise. While central banks would prefer to overlook a temporary spike in energy prices, if they remain elevated for a long period, it may feed through into higher core inflation as businesses pass on higher transport and production costs.
This would hamper central banks’ ability to cut interest rates to cushion the anticipated growth slowdown from President Trump’s tariffs, which adds another variable for the Fed to consider when it meets to discuss interest rates this week.
FOMC interest rate decision
Date: Thursday, 19 June at 4.00am AEST
At the last FOMC meeting in early May, the Federal Reserve kept the Fed Funds rate on hold at 4.25% – 4.50%. The Fed cited increasing uncertainty about the economic outlook, noting that “the risks of higher unemployment and higher inflation have risen.” Fed Chair Powell also expressed optimism, stating, “The economy itself is still in solid shape,” and indicating that the Fed doesn’t need to rush to cut rates while it takes time to assess the impact of President Trump’s tariffs on the economy.
Since the May meeting, while the soft data, including consumer and business surveys, has been weak, the hard data, including last week’s non-farm payrolls report, has held up better than expected given the impact of tariff and trade disruptions. On inflation, the Fed’s preferred measure, the core PCE price index, most recently at 2.5%, has yet to show any signs of tariff-related inflationary concerns.
Considering this, the Fed is expected to keep the Fed Funds rate unchanged at 4.25% – 4.50%, reflecting its cautious “wait and see” approach. Fed Chair Jerome Powell is expected to emphasise data dependency in his press conference, avoiding firm commitments and resisting political pressure from President Donald Trump to cut rates. The US rates market finished last week pricing in an 83% chance of a 25 basis point Fed rate cut for September, with a cumulative 54 bp of Fed rate cuts priced by year-end.
Fed funds rate chart