Middle East Remains in Focus for Markets

STOCK INDEX FUTURES

Stock index futures edged higher before the bell as investors grappled with the possibility of direct US military involvement in the Israel-Iran conflict after President Trump introduced a two-week time limit on deciding on military action. European negotiators are set to meet with Iranian officials today over its nuclear program to help avert further escalation in the conflict that is entering its second week. Stocks have struggled since the attacks began, putting the major indexes on track to end the week with losses.

The Philadelphia Fed manufacturing index for June was -4.0, matching May’s figure and below expectations of -1.7, as manufacturing has slowed as tariffs dampen global demand for goods. Investors will turn their attention to the Conference Board’s Leading Economic Indicators for May out at 9:00 a.m. CT.

Retail sales in May shrank -0.9% from April, lower than expectations of a -0.5% fall in spending and a falloff from April’s growth of 0.1% as consumers grow anxious over the larger economic picture and look to hold onto their wallets. May sales excluding auto and gas declined -0.1%, showing the drop in sales was largely attributed to consumers laying off auto and gas purchases after splurging in previous months to get ahead of tariffs. Economists had expected a 0.3% rise. Many businesses stockpiled items to get ahead of Trump’s tariffs, and price increases are expected to show up later this summer or in the fall.

Stock valuations are still relatively high by historical standards; the S&P 500 was trading near 23 times its expected earnings over the next 12 months as of June 13, versus a 10-year average of 18.7 times. The high price-to-earnings ratio is at odds with the current macro environment, which has seen central banks and private companies across the globe cut their growth forecasts due to the still-unfolding consequences of uncertain trade policies.

CURRENCY FUTURES

The USD index is lower but on track to finish the week higher, as the ongoing conflict between Israel and Iran has driven safe-haven demand for the dollar and as the Fed kept interest rates unchanged at its latest meeting. Fed Chair Jerome Powell warned that inflation could pick up in the coming months, partly due to the inflationary effects of President Trump’s tariffs. The Fed also downgraded its economic growth outlook and reaffirmed expectations for two 25 bps rate cuts in 2025.

Euro futures are higher as the dollar slipped. The European Central Bank earlier this month lowered its key interest rate to 2% from 2.25%, its eighth cut since June 2024. That followed data showing the annual rate of inflation in the eurozone was 1.9% in May, lower than the ECB’s 2% target. The soft inflation has led some ECB officials to raise signals that the central bank should be done with or near the end of its monetary policy easing cycle. Wages in the eurozone grew at 3.40%, over expectations of a 3.20% growth, although the figures are down from a 4.10% increase the previous quarter and marked the slowest pace of wage growth since Q3 2023.

British pound futures are higher after the Bank of England kept interest rates unchanged amid a backdrop of sticky inflation and an economic slowdown as a result of tariffs. The bank warned of “two-sided risks to inflation,” noting that price growth is likely to remain broadly stable through the rest of the year before easing back toward target in 2026. Retail sales data out of the UK also showed that shoppers drew back on spending, with sales contracting -2.7% from April to May, below the expected contraction of -0.5%. May’s drop was the sharpest monthly drop since the end of 2023 and was driven by a decline in food store sales. Employer tax increases and a rise in utility bills, both of which came into effect in April, look to be hitting retailers and consumers at once.

Japanese yen futures fell despite core CPI inflation reaching its highest level since January 2023 at 3.7%, up from April’s 3.5% increase and above economists expectations of a 3.6% rise. Persistent price growth is complicating the central bank’s policy stance, as tariff-related uncertainty makes it harder to determine the right timing for raising rates to curb inflation. Food inflation continued in May, with rice prices more than doubling despite the government’s efforts to cool prices of the staple. Energy costs rose 8.1% on the year, though that was a slowdown from April’s 9.3% increase.

Australian dollar futures are lower after labor data published on Wednesday showed the economy lost 2,500 jobs in May, a sharp contrast to expectations of a 25,000 figure growth, while the unemployment rate held steady at 4.1%. Expectations of a July rate cut are priced in at 75%, while some analysts expect an August cut given the Reserve Bank of Australia’s preference for caution and the need to assess second-quarter inflation. Markets now turn to upcoming PMI figures for greater clarity on Australia’s economy.

INTEREST RATE MARKET FUTURES

Futures are lower across the curve, with longer-dated yields down the steepest as investors weigh rising geopolitical risks against the economic backdrop. The Fed held rates steady at its latest policy meeting on Wednesday while also updating its summary of economic projections. The Fed expects GDP to rise 1.4% in 2025 and 1.6% in 2026 and maintains their prediction of two more rate cuts by the end of the year. Fed Chairman Jerome Powell noted that conditions in the labor market have held up well and are in line with a balanced labor market. Longer-term inflation measures remain consistent with the Fed’s longer-term goal, and inflationary pressures from tariffs will likely be felt in the coming months. The Fed did note it was unsure as to whether the inflationary pressure from tariffs would be a one-time increase or a persistent problem. Attention will turn to next week’s data, including PCE, the Federal Reserve’s preferred gauge of inflation.

Market participants continue to pay close attention to the tax and spending bill making its way through the Senate right now, which is set to provide some short-term stimulus but also increase the size of the US debt load over the next decade. The bill would also raise the debt ceiling by $5 trillion and add to expectations that the US Treasury Department would need to increase the size of its bond issuance in order to continue financing the government’s growing debt problem.

Despite a recent rally in the bond market over the last couple of weeks and strong demand at recent Treasury auctions, foreign central banks appear to be quietly trimming their exposure to US debt securities. The New York Fed’s latest ‘custody’ data shows a steady decline in the value of Treasurys and other US securities held on behalf of foreign central banks. Last week’s figures (which are updated weekly) showed a $17.1 billion decline, and the total value of US debt securities – including mortgage-backed bonds – has fallen around $90 billion since March. The moves signal that foreign bank FX reserve managers are cutting exposure to US bonds. Central banks are traditionally stable, long-term holders of Treasurys, and their gradual retreat could make the market more sensitive to other investor flows.

The 10-year Treasury yield is 4.43%, and the 30-year yield is 4.93%. The spread between the two- and 10-year yields rose to 47 bps from 43 bps on Wednesday.

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