Middle East risk ebbs, US stocks rebound; Goldman Sachs says upward trend will continue with need for Fed to resume rate cuts.

The situation in the Middle East has further eased, with Iran announcing that the Strait of Hormuz is now "fully open" to commercial shipping. Prior to this, the US stock market had rebounded significantly. As geopolitical risks diminish, Goldman Sachs believes that in order for the US stock market to maintain its upward momentum, the Federal Reserve needs to reconsider its stance on interest rate cuts. Christian Mueller-Glissmann, head of asset allocation research at Goldman Sachs, described the recent strong rebound in the US stock market as a "rapid and fierce recovery phase," attributing some of the rebound to technical factors such as hedge funds that had previously sold stocks to reduce risk now being forced to redeploy. While the S&P 500 index seems to be on track for a third consecutive week of gains of over 3%, Mueller-Glissmann still questions the sustainability of this rally in the absence of monetary policy support. He points out that in order to maintain the upward momentum in the US stock market, the Federal Reserve needs to reconsider its stance on interest rate cuts. In an interview, Mueller-Glissmann said, "To sustain this recovery and continue the rally, I believe we need the Fed to return to its previous policy stance to some extent. We need to see relief from interest rate pressures." He also noted that while the stock market has risen significantly, oil prices remain high and the performance of the credit market lags behind the stock market. He attributed some of the stock market's strong performance to higher exposure to tech stocks, which continue to deliver good results. Federal Reserve policy dilemma Despite investors recently treating headlines related to the Middle East conflict as trading noise and reembracing the fundamental resilience of corporate earnings in the latest earnings season, the negative impact of the conflict on US economic growth and inflation cannot be ignored. William Williams, president of the New York Fed, said on Thursday that the Middle East conflict has begun to have a substantial impact on the US economy, leading to increased upward pressure on prices and a slowdown in economic growth momentum. Speaking to banking industry professionals in his district, he pointed out that this conflict has further increased the uncertainty about the prospects for the US economy. While he still expects growth to continue this year and inflation to gradually ease, he also acknowledged that the Fed is currently facing the dual risks of rising inflation and slowing economic activity. Williams said that if energy supply disruptions can be alleviated quickly, energy prices should fall, and the related impact may partially reverse later this year. But he also warned that if the conflict evolves into a larger-scale supply shock, it could further increase inflation and suppress economic activity by pushing up intermediate input costs and commodity prices, a trend that "is already beginning to show." St. Louis Fed President James Bullard similarly said that "supply shocks are threatening the Fed's dual mandate of inflation and employment," and noted, "The current rate range may still be appropriate for a period of time." He also said, "Oil price shocks may be transmitting to core inflation, which means core inflation may stay close to 3% by the end of this year." Even John Milan, a Fed governor who has always supported larger and more frequent interest rate cuts, has slightly changed his stance recently. Milan said on Thursday that he has converged his position on interest rate cuts, as inflation appears more stubborn, and he now believes that the reasons for adopting accommodative monetary policy are not as compelling as before. He had originally expected four rate cuts this year, but now he is more inclined to three. Milan said that since December last year, the inflation situation has worsened, but this was not entirely caused by the Middle East conflict. In fact, he had observed this trend in the months before the conflict broke out. Milan pointed out that the fundamental composition of inflation has become more complex, with contributions from other sectors increasing, making the situation more complicated than at the beginning of the year. Milan currently believes that the Fed should move towards a neutral interest rate, estimated to be as low as 2.5%. He expects the inflation rate to reach the Fed's 2% target level in about a year. As for the labor market, Milan sees no reason to believe that the cooling trend in the labor market will not continue. Therefore, given the weak job market, he advocates for rate cuts now. In summary, the dual risks of rising inflation and slowing economic growth brought about by the Middle East conflict have put the Fed in a decision-making dilemma. As of the time of writing, the CME Group's "FedWatch" tool shows that the market expects a 62.9% probability that the Fed will keep the benchmark interest rate unchanged by the end of 2026. At the monetary policy meeting on March 17 to 18, the Fed announced that it would maintain the target range for the federal funds rate at 3.5% to 3.75% for the second consecutive time. Although most officials still expect at least one rate cut this year, according to the forecasts released after the meeting, concerns are increasing. Many policymakers emphasize that the risk of rising inflation may eventually require hiking rates. The likelihood of inflation staying above the 2% target for a longer period has significantly increased. The minutes of the March meeting show that the majority of participants judged that progress towards achieving the 2% inflation target was slower than previously expected, and the risk of inflation persistently exceeding the target level has increased. At the same time, most officials are concerned that if the conflict persists for a long time, it may impact the labor market, necessitating rate cuts. Many officials warn that in an environment of low net job creation, the labor market is vulnerable to negative impacts. Prolonged Middle East conflict may curb business sentiment and further shrink job openings. In fact, even before the outbreak of the Middle East conflict, the Fed's scope for rate cuts had already narrowedthe labor market had stabilized, alleviating concerns about an economic recession, and the progress towards inflation falling to the Fed's 2% target had stalled. Taking into account the information released in the meeting minutes and the current market conditions, the highest probability in the short term is that the Fed will maintain the interest rate unchanged, with low probabilities of an immediate hike or cut. Regarding the threshold for rate hikes, while a few officials do hold an openness to hiking rates, the majority of officials assess that it is "too early to evaluate the impact of the Middle East situation on the economy," leaning towards a cautious wait-and-see approach. As for the conditions for rate cuts, the minutes clearly outline the scenarios that could trigger further rate cuts, indicating that if the Middle East conflict continues to worsen the labor market conditions, an accelerated pace of rate cuts may be necessary. However, the better-than-expected March nonfarm payrolls data does not fit this scenario assumption, temporarily easing the urgency for rate cuts from the Fed in the short term. Some analysts suggest that the Fed's monetary policy direction will largely depend on external variables beyond its control, namely the duration and intensity of the Middle East conflict. In this situation, the Fed's policy direction is likely to exhibit a characteristic of "wait and seewait for datadecide cautiously." The Fed will announce its rate decision on April 29. This decision will be a key test for the Fed's monetary policy outlook. The market currently widely expects the Fed to keep the rate unchanged. Therefore, any changes in the wording of the decision statement and the remarks of Fed Chair Powell at the press conference will be crucial for the market to assess the Fed's monetary policy path. Succession of the Fed Chairmanship May Face Challenges, Trump's wish for rate cuts may be hard to fulfill At the same time, the process of "handover" of the Fed chairmanship is currently facing challenges, which may become a variable affecting the Fed's monetary policy path. The Senate Banking Committee is expected to hold a confirmation hearing next week for Judy Shelton, whom President Trump has nominated for the Fed chairmanship. This hearing will provide a platform for senators from both parties to examine Shelton's positions on economic and monetary policy. Shelton has previously served as a Fed governor and as an economic policy advisor to Trump. Investors are especially interested in how Shelton will balance competing forcespressure from Trump to significantly lower borrowing costs on one hand, and economic conditions that do not yet support rate cuts on the other. Given the Trump administration's repeated attacks on the Fed and the fact that inflation has been above the central bank's target for over five years, any missteps in answering questions about rate issues could weaken the credibility of the Fed under Shelton's leadership. However, even if Shelton's performance at the committee hearing is flawless, there is uncertainty in Shelton's path to Senate confirmation as long as the Justice Department's investigation into Powell continues. Republican Senator Thom Tillis of North Carolina has stated that he will not support any nominee until the criminal investigation is resolved, as he believes the investigation threatens the Fed's independence. President Trump reiterated this week that if Powell does not resign from the Fed on time, he will take action to dismiss him. While Powell's term as Fed Chair will expire on May 15, his term as a board member will continue until January 2028. As is customary, a departing Fed Chair typically resigns from the institution after leaving leadership duties, but Powell stated in March that he would stay until the Justice Department's investigation is resolved "in a transparent and final manner." Trump stated that he does not intend to drop the Justice Department's investigation into Powell, and reiterated the need to investigate issues related to the Fed's headquarters building project. The unexpected search of the construction zone at the Fed headquarters earlier this week indicates that the Justice Department has not abandoned its investigation into Powell, and earlier this month U.S. District Judge Boasberg upheld a related ruling dismissing a subpoena against Powell. If Shelton cannot be confirmed before May 15, Powell has stated that he plans to serve as acting chair, and may continue to hold his other key position as chair of the Federal Open Market Committee (FOMC) responsible for setting rates. This means that the Trump administration's ongoing investigation could not only delay Shelton's confirmation, but also allow Powell to retain significant control over monetary policy. Corporate Earnings Resilience is the Key Foundation! Wall Street Loudly Bullish on US Stocks While Fed policy remains in a fog, several Wall Street institutions have been "raising their hands" for the outlook of US stocks, with the market already looking forward to a new bull market led by tech stocks. Veteran stock market strategist and co-founder of Fundstrat, Tom Lee, known as the "Wall Street Whiz," believes that the current position of the US stock market and even global stock markets is stronger than when they reached the previous high earlier this year. Tom Lee agrees with a typical assessment by the Wall Street financial giant JPMorgan, that the tech sector anchored by AI computational infrastructure will lead the next super bull market phase of stock markets. Citigroup has raised its rating on US stocks from "neutral" to "overweight," and expects the S&P 500 index to reach 7,700 points by the end of the year. The bank's latest research report shows that the tech sector, which had been suppressed by geopolitical conflicts, valuation anxieties, and overblown expectations, is entering a window of risk preference recovery shifting to fundamental reassessment. With the marginal easing of the Middle East situation, the market has swiftly switched back to risk assets, with the S&P 500 and Nasdaq rallying in sync, indicating that funds are once again trading the "future overall profit growth trajectory underpinned by AI" rather than the "current panic." In this framework, tech stocks, especially large tech platforms, are no longer just clusters driven by liquidity but have become the core anchor for risk preference and profit expectations in the US stock market. BlackRock's stock strategist has switched back to "overweight" US stocks. BlackRock emphasizes the latest US earnings season, proclaiming that the profit growth engine can support the main theme of the US stock bull market. The strategist wrote, "Even during the period of geopolitical conflict, corporate earnings expectations continue to rise, with much of the logic and reasons attributed to the strong demand for AI-related investment themes." In conclusion, the narrative of a new bull market in US stocks is supported by three main logics: the fundamental resilience of corporate earnings demonstrated in the latest earnings season, the resurgence of risk preference driven by the tech/AI theme, and the market's judgment that the Middle East shock will not evolve into a prolonged inflationary period like in 2022. As long as these three logical pillars remain intact, and against the backdrop of easing Middle East tensions, US stocks are expected to continue to strengthen.