Stock Market’s Perfect Storm: Hormuz, Inflation, and the Fed

U.S. stocks logged their fourth straight week of losses. The DJIA (DJIA) tumbled 2.11% over the week, bringing its loss since the start of the year to 5.17%. The Nasdaq-100 (NDX) notched similar results, down 1.98% for the week and 5.35% year-to-date. As the most diversified large-cap index, the S&P 500 (SPX) fared slightly better, losing 1.90% for the week and down 4.95% for the year through March 20. Still, the S&P 500 slipped below its 200-day moving average for the first time in more than a year. This is a classic inflection point, from which the index can either rebound or continue down into a deeper decline. With volatility and geopolitical risks rising, this week doesn’t look very promising in terms of a rally, as dip-buyers remain wary in the near-absence of positive macro news.      

The Iran war is raging on, and shipping through the Strait of Hormuz remains largely suspended, with the flow of ships through the strategic waterway slowing to a trickle. Although the ayatollah regime’s ability to launch attacks has massively diminished, shipping companies remain reluctant to send their vessels through the waterway. At the same time, the Iranian drone attack on refineries in Kuwait, along with Iraq’s declaration of force majeure because of its inability to ship crude through the Strait, added to the upward pressures on prices of oil, gas, and related commodities. Crude prices whipsawed through the week, chasing headlines, and while updates from the U.S. and Israel helped bring them down from their panic highs, they remain at levels that keep inflation, interest rates, and pressure on the consumer firmly in the conversation.  

As if to highlight this focus, February’s wholesale inflation numbers came in notably above forecasts, signaling that inflation had become an issue for policymakers even before the first missile landed in the Middle East. Rising producer-price inflation tends to find its way into consumer indexes much faster than spiking crude, which means that the next CPI and PCE releases will probably not be pretty.

This week, another batch of macro data will hopefully add some clarity, with a specific focus on the consumer sentiment index, which outlines the health of the demand side of the economy. Moreover, one of the index’s components – the long-term inflation expectations figure – is of utmost importance, having been selected by the Fed as one of the inputs for its inflation outlook and thus affecting interest-rate forecasts.

Wednesday’s Federal Reserve decision to keep rates unchanged didn’t surprise anyone, but the increased caution signaled by policymakers further pressured sentiment. The central bank continues to see “solid” economic expansion despite the sharp slowdown last quarter, and says that although job gains remain low, the labor market remains “healthy.” At the same time, policymakers acknowledged a growing layer of uncertainty, noting that “the implications of developments in the Middle East for the U.S. economy are uncertain.” Despite the elevated uncertainty, the Fed hiked both its GDP growth and inflation forecasts. On the surface, it means that one rate cut is still on the table this year. However, Chair Jerome Powell’s rhetoric sounded far more hawkish than the Fed’s “dot plot” – its table of economic projections – suggested, leading traders to abandon hope for cuts, while pricing in a ~40% chance of a rate hike by July.

Besides the Hormuz trouble, all eyes are also on the Iranian-funded Yemeni terrorist group, the Houthis, which may enter the fray, imperiling the alternative naval oil export route through the Red Sea. For now, the Houthis have stayed on the sidelines, arguably as a result of the Israeli strikes last year that removed all their top commanders and degraded their capabilities. Meanwhile, the base-case outlook across Wall Street assumes Middle East de-escalation within four to six weeks, as there is no doubt that the U.S. and Israel will soon subdue the Iranian regime’s warfare capabilities. This could lead to oil prices stabilizing at $70-80 as shipping restarts first and then production gradually resumes. If these forecasts hold, the rise in inflation because of higher oil prices will be short-lived, allowing Fed cuts to be priced in again. This is a small price to pay for the long-term stability in energy prices that will be gained once the regime holding hostage the Strait of Hormuz – and the whole region, if not beyond – is defeated.

For now, though, stock markets are battered by a triple whammy of surging oil prices, a weakening job market, and diminished prospects for rate cuts. This negative impact of this combination on investor sentiment has outweighed a surge of exciting news emanating from NVIDIA’s (NVDA) annual GTC conference, with the global tech leader signaling that the AI capex surge – which may already be adding to GDP growth – is only beginning. Other positive news, such as FedEx’s (FDX) beat-and-raise – a direct signal of resilient consumer demand – and strong rally in Dell (DELL), was also completely drowned out by macro negativity.        

Still, strong market fluctuations in response to a flurry of conflicting headlines is not new. We have seen this several times in the past few years, starting with the relatively long episode of the Covid-19 pandemic, through the very short-lived regional banking panic in the spring of 2023, then the “tariff tantrum,” then the DeepSeek frenzy that temporarily wiped out $1 trillion from major U.S. tech indices – to name just the major shocks. Every single time, stocks rebounded in force, rewarding investor patience.