S&P500: Bearish Forecast as Prolonged War and Rate Hike Chatter Hit US Indices

Stocks Slide as Rate Hike Talk Creeps Back Into the Conversation

The major U.S. stock indexes are down after the first hour of trading on Friday as investors continue to monitor the U.S.-Iran war as well as high oil prices, rising inflation, the odds of a Fed rate cut and now, even the chances of a Fed rate hike. The indexes are also on pace for another weekly loss.

At 14:23 GMT, the blue chip Dow Jones Industrial Average is trading 45718.60, down 302.83 or -0.66%. The benchmark S&P 500 Index is at 6543.18, down 63.31 or -0.96% and the tech-heavy Nasdaq Composite is trading 21811.437, down 279.254 or -1.26%.

This Market Has Been Orderly but Boots on the Ground Changes Everything

Stocks have been losing ground since the war began on February 28, but not at the pace that many had expected. But so far the war has been fought with missiles, rockets and bombs. Conditions could change in both the war and the markets if the Pentagon decides to put boots on the ground.

The financial markets have been getting just a taste of what war in the Middle East is like with the spike in oil prices, infrastructure damage and predictions of higher inflation. But if the report from The Wall Street Journal is true and the U.S. is considering sending in troops then this could be a game-changer for stocks. The markets have been selling off on cruise control, but if there is actual fighting the sell-off in stocks will become more pronounced.

Trump Is Focused on the Strait, Not the Marines

President Trump doesn’t seem to be too focused on sending in the Marines, his focus has been on opening the Strait of Hormuz. What seemed to be an afterthought when the war began over three weeks ago, has now moved to the forefront. I haven’t seen much reporting on whether the U.S. has captured any Iranian Uranium, but I see every day, the urgency to get the Strait open to oil traffic.

With the Strait closed, we don’t need oil at $150 a barrel, we just need to see a consistent price over $100 a barrel to cause problems with inflation and economic growth. All of this will then trickle down to the Federal Reserve, whose main purpose is to keep the labor market intact and to contain inflation around the 2% level. It seems to be doing alright with the jobs market right now, but that can change quickly if there is a prolonged war. High inflation, on the other hand, will be a little more difficult to control because the Fed’s strongest weapon to combat it is an interest rate hike.

From Three Rate Cuts to Zero and Now Nobody Is Ruling Out a Hike

We started out the year with investors looking for at least three rate cuts, slowly the call deteriorated to just one at the last meeting on Wednesday, and the odds of that taking place have been pushed into December.

Following the progression of more cuts to some cuts to no cuts, we naturally drift into the possibility of an interest rate hike by the Fed. Yes, traders are starting to look at that with MarketWatch reporting a 10% chance of an April hike and a 17% chance of a rate hike by the end of the year. Now we haven’t seen any reports of traders betting on a 50% chance of a rate hike, but Investopedia, quoting the Atlanta Fed tracker, thinks there’s a 25% chance of a hike within 3 months.

I’m just going to say that the Iran War and higher oil prices have put rate hikes “back on the table” because of reduced confidence in rate cuts. I think there is going to be a directional shift by the Fed, but probably not a rate hike spike to 50% over the near-term.

Nonetheless, anything can happen quickly if the Pentagon puts boots on the ground and oil prices have a sustained rally over $100 a barrel. Start bracing for further downside pressure, because a prolonged war, high inflation and a rate hike are all pretty bearish elements.

More Information in our Economic Calendar.