Fed to decide amid trade, geopolitical chaos

US stocks sold off, oil and natural gas rallied, and the US dollar gained as US Treasuries and gold attracted safe-haven flows. Mounting tensions between Israel and Iran, alongside Donald Trump’s early departure from the G7 meeting, spurred concerns that the US could become involved in the Middle East crisis.

Investors are taking risk off the table, bracing for further escalation and a potential prolongation of tensions with Iran. China is on edge, as it buys oil from Iran, while Russia is uneasy about seeing one of its last key allies under growing threat. Israel, for its part, wants to eliminate the nuclear threat, and the US appears to be warming to the idea of regime change in Iran.

That’s the geopolitical setup, and the market’s reaction is broadly in line with expectations. US crude jumped more than 5% on Tuesday and is now consolidating near the $75 per barrel level. Natural gas added around 3.5% and is pushing toward $4 per MMBtu. Inflows into gold have remained limited over the past two sessions, as the US dollar attracted most of the safe-haven demand.

The US dollar index is under some pressure this morning, with the EURUSD rebounding from the 1.1475 mark and Cable finding buyers into 1.34. The US 10-year yield stands near 4.40% this morning — down from above 4.60% in mid-May.

Further escalation would likely support demand for longer-maturity US Treasuries, help the US dollar recover part of its trade-related losses, and lift gold prices toward all-time highs. At the same time, oil prices could stay supported on fears that Iran — if pushed — might block energy flows through the Strait of Hormuz, where roughly 20% of global oil and gas supply transits.

Germany is reportedly considering building gas reserves — a smaller version of the US Strategic Petroleum Reserve — while tanker rates for oil shipments have surged in recent days, adding further pressure to energy costs. And if that weren’t enough, two oil tankers collided and three ships caught fire near the Strait of Hormuz, reviving suspicions of Iranian involvement — as seen in 2019. The exact cause remains unclear. What is clear is that the region is boiling over, and betting against an oil rally at this stage would be highly uncomfortable. If trade through the Strait becomes constrained, oil prices could easily spike above $100 per barrel. Such a rally may not be sustainable, but it would be enough to fuel global inflation worries and prompt central banks to maintain a cautious, hawkish stance.

Fed decides

All this sets the stage for the Federal Reserve’s (Fed) latest policy decision and the release of its updated dot plot later today. The Fed is not expected to change rates at this meeting. The base case remains two rate cuts this year, with the first likely not before September, according to Fed funds futures pricing. The probability of a September cut stands around 63% ahead of today’s decision.

While the economic projections and dot plot could shift market expectations, rising geopolitical and trade uncertainties mean the Fed’s growth and inflation forecasts may lack precision. Any indication from the dot plot should be taken with a grain of salt. It’s likely the Fed will reiterate that policy is in a good place and that further decisions will be data-dependent.

On the data front, jobs numbers have remained surprisingly steady despite mass deportations, tariff-related uncertainty, and broader macro headwinds. Inflation came in softer than expected last month, despite a prior jump in inflation expectations to multi-decade highs. Yesterday’s retail sales data showed US consumer spending fell for the second straight month, with the decline accelerating, while industrial production also slipped. While that might have raised hopes for earlier action, the Fed has little reason to move amid such limited visibility.

At best, the dot plot will point to two rate cuts in the final four months of the year. At worst, it may show weaker growth projections and higher inflation forecasts — and a Fed urging patience. If that’s the case, the S&P500 could top near the 6000 mark and enter a correction heading into summer, with investors facing a heavy geopolitical and trade negotiation agenda.