Middle East risk recedes, U.S. stocks rebound; Goldman Sachs states that the rally will continue if the Federal Reserve resumes interest rate cuts

According to the Zhitong Finance APP, the situation in the Middle East has further eased, with Iran announcing that the Strait of Hormuz is currently "fully open" to commercial shipping. Prior to this, U.S. stocks had rebounded significantly. As geopolitical risks recede, Goldman Sachs believes that for U.S. stocks to maintain this upward momentum, the Federal Reserve needs to shift back to a rate-cutting stance.

Christian Müller-Glißmann, head of asset allocation research at Goldman Sachs Group, described the recent strong rebound in U.S. stocks as a "rapid and fierce recovery phase," noting that part of the rebound is driven by technical factors—hedge funds that previously sold stocks to reduce risk are now being forced to rebuild their positions.

Although the S&P 500 index seems to be on track for a third consecutive week of gains exceeding 3%, Müller-Glißmann still questions the sustainability of this rally in the absence of monetary policy support. He pointed out that to maintain this upward momentum in U.S. stocks, the Federal Reserve needs to revert to a rate-cutting stance.

In an interview, Müller-Glißmann stated, "To sustain this recovery and keep this rally going, I think we need the Federal Reserve to return to its previous policy stance to some extent. We need to see relief in interest rate pressures."

He also noted that despite the significant rise in the stock market, oil prices remain high, and the performance of the credit market lags behind that of the stock market. He attributed part of the stock market's strong performance to a higher exposure to technology stocks, which continue to "deliver good earnings reports."

Federal Reserve in a Policy Dilemma

Despite investors recently choosing to treat headlines related to the Middle East conflict as trading noise and re-embracing U.S. stocks led by technology stocks in the latest earnings season, the negative impact of this conflict on U.S. economic growth and inflation cannot be ignored.

The Federal Reserve's "number three," New York Fed President John Williams, stated on Thursday that the Middle East conflict has begun to have a substantial impact on the U.S. economy, manifesting as increased price pressures and slowing economic growth momentum. In a speech to regional banking professionals, he pointed out that this conflict has further exacerbated the uncertainty surrounding the U.S. economic outlook. Although he still expects the economy to maintain growth and inflation to gradually decline this year, he also acknowledged that the Federal Reserve is currently facing dual risks of rising inflation and economic slowdown.

Williams stated that if energy supply disruptions can be alleviated quickly, energy prices should fall, and the related shocks may partially reverse later this year. However, he also warned that if the conflict escalates into a larger-scale supply shock, it could further raise inflation and suppress economic activity by pushing up intermediate input costs and commodity prices, a trend that "has already begun to manifest."

St. Louis Fed President James Bullard also stated, "Supply shocks are threatening the Federal Reserve's dual goals of inflation and employment," and noted that "the current interest rate range may still be appropriate for some time." He added, "The oil price shock may be transmitting to core inflation, which means core inflation could remain close to 3% by the end of this year."

Even Federal Reserve Governor Michelle Bowman, who has consistently supported larger and more frequent rate cuts, has shown a slight change in attitude recently. On Thursday, Bowman stated that her stance on rate cuts has moderated, as inflation appears to be more stubborn, and she now believes that the rationale for adopting an accommodative monetary policy is not as compelling as it was before He originally expected to cut interest rates four times this year, but now he is more inclined to cut rates three times.

Milan stated that the inflation situation has worsened since last December, but this is not entirely due to the Middle East conflict. In fact, he observed this trend months before the outbreak of the war. Milan pointed out that the fundamental composition of inflation has become more complicated, "the contributions from some other sectors have started to increase, so the situation is more complex than it was at the beginning of the year."

Milan currently believes that the Federal Reserve should move towards a neutral interest rate, which is estimated to be as low as 2.5%. He expects the inflation rate to reach the Federal Reserve's 2% target level in about a year. Regarding the labor market, Milan sees no reason to believe that the cooling trend in the labor market will not continue. Therefore, given the weakness in the labor market, he advocates for a rate cut now.

Overall, the dual risks of inflationary pressures and economic growth slowdown brought about by the Middle East conflict are putting the Federal Reserve 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 Federal Reserve will keep the benchmark interest rate unchanged until the end of 2026.

At the monetary policy meeting on March 17-18, the Federal Reserve announced that it would maintain the federal funds rate target range at 3.5% to 3.75%, marking the second consecutive time it has kept rates unchanged. Although most officials still expect at least one rate cut this year in the forecasts released after the meeting, the minutes from the March meeting show that increasing concerns are emerging.

Many policymakers emphasized that the upside risks to inflation may ultimately require rate hikes. The likelihood of inflation remaining above the 2% target for a longer period has clearly increased. The minutes from the March meeting indicate that the vast majority of participants judged that progress towards the 2% inflation target was slower than previously expected, and the risk of inflation remaining above the target level has increased.

Meanwhile, most officials are concerned that if the conflict continues for a long time, it may impact the labor market, necessitating rate cuts. Many officials warned that in the current environment where the number of new net jobs is low, the labor market is vulnerable to negative shocks. A prolonged conflict in the Middle East could suppress business sentiment and lead to further contraction in hiring.

In fact, even before the outbreak of this Middle East conflict, the space for the Federal Reserve to cut rates had already narrowed— the labor market had stabilized, alleviating concerns about an economic recession, while the process of inflation returning to the Federal Reserve's 2% target had stalled.

Considering the information released by the Federal Reserve in the minutes and the current market conditions, the probability of the Federal Reserve maintaining interest rates unchanged in the short term is the highest, with the likelihood of an immediate rate hike or cut being low. Regarding the threshold for rate hikes, although there are indeed a few officials open to the idea of raising rates, most officials judge that it is "too early" to assess the impact of the Middle East situation on the economy, leaning towards a cautious wait-and-see stance.

As for the conditions for rate cuts, the minutes clarified the scenarios that could trigger further rate cuts, namely, if the ongoing Middle East conflict leads to further deterioration in the labor market, it may necessitate a faster pace of rate cuts. The stronger-than-expected U.S. non-farm payroll data in March does not align with this scenario assumption, temporarily alleviating the urgency for the Federal Reserve to cut rates in the short term Analysts have indicated that the direction of the Federal Reserve's monetary policy will largely depend on external variables beyond the Fed's control, namely the duration and intensity of the ongoing conflict in the Middle East. In this context, the Fed's policy direction is likely to exhibit characteristics of "wait-and-see—data-dependent—discretionary decision-making."

The Federal Reserve will announce its interest rate decision on April 29. This decision will serve as a critical test for the outlook of the Fed's monetary policy. The market currently widely expects that the Fed will maintain interest rates unchanged at that time. Therefore, any changes in wording in the Fed's decision statement, as well as comments made by Fed Chairman Jerome Powell at the press conference, will become important references for the market's assessment of the Fed's monetary policy path.

If the Transition of the Fed Chair is Not Smooth, Trump's Wish for Rate Cuts May Be Difficult to Fulfill

Meanwhile, the "handover" process of the Fed Chair is currently not going smoothly, which may become a variable affecting the Fed's monetary policy path.

The U.S. Senate Banking Committee is expected to hold a confirmation hearing next week for Trump's nominee for Fed Chair, Christopher Waller. This hearing will serve as a platform for bipartisan senators to examine Waller's positions on economic and monetary policy. Waller previously served as a Fed governor and was an economic policy advisor to Trump. Investors are particularly concerned about how Waller will balance the competing pressures—on one hand, the demand from Trump for significantly lower borrowing costs, and on the other hand, the economic conditions that are not yet sufficient to support rate cuts, at least in the short term.

Given the Trump administration's repeated attacks on the Fed and the fact that inflation has been above the central bank's target for more than five consecutive years, any missteps in answering questions related to interest rates could undermine the credibility of the Fed under Waller's leadership.

However, even if Waller performs flawlessly at the committee hearing, as long as the Justice Department's investigation into Powell is ongoing, there remains uncertainty regarding Waller's path to Senate confirmation. North Carolina Republican Senator Thom Tillis has stated that he will not support any nominee until the criminal investigation is resolved, as he believes the investigation threatens the independence of the Fed.

This week, Trump reiterated that if Powell fails to leave the Fed on time, he will take action to dismiss him. Although Powell's term as Fed Chair will expire on May 15, his term as a board member will continue until January 2028. Traditionally, an outgoing Fed Chair fully resigns from the institution after their leadership term ends, but Powell stated in March that he intends to stay until the Justice Department's investigation is resolved "in a transparent and final manner."

Trump has indicated that he does not intend to abandon the Justice Department's investigation into Powell and reiterated the necessity of investigating issues related to the Fed building project. The recent raid by U.S. prosecutors on the construction area of the Fed headquarters also indicates that the Justice Department has not given up on the investigation into Powell, and earlier this month, a U.S. district court judge upheld the decision to dismiss the subpoena against Powell.

If Waller fails to gain confirmation before May 15, Powell has stated that he intends to serve as interim chair and may continue to hold another key position—chair of the Federal Open Market Committee (FOMC), which is responsible for setting interest rates. This means that the Trump administration's continued pursuit of the investigation could not only delay Waller's confirmation but also allow Powell to retain significant control over monetary policy

Corporate Profit Resilience is an Important Cornerstone! Wall Street is Bullish on U.S. Stocks

Despite the Federal Reserve's policies remaining shrouded in uncertainty, supported by corporate profit resilience, several Wall Street institutions have recently raised their voices in favor of the outlook for U.S. stocks, with the market beginning to anticipate a new bull market led by technology stocks.

Tom Lee, a veteran stock market strategist and co-founder of Fundstrat, known as the "Wall Street Oracle," believes that the current position of the U.S. stock market, and even the global stock market, is stronger than when it reached its previous historical high earlier this year. Tom Lee agrees with a typical judgment from Wall Street financial giant JP Morgan, which states that the technology sector, centered around AI computing infrastructure, will lead the next super bull market phase.

Citigroup has upgraded its rating on U.S. 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 technology sector, previously suppressed by geopolitical conflicts, valuation anxieties, and overly high expectations, is now entering a window of fundamental reassessment driven by a recovery in risk appetite. After the marginal easing of the situation in the Middle East, the market quickly shifted from safe-haven assets back to risk assets, with the S&P 500 and Nasdaq strengthening simultaneously, indicating that funds have begun to re-trade the "future overall profit growth trajectory driven by AI" rather than "current panic." Within this framework, technology stocks, especially large tech platforms, are no longer merely liquidity-driven collective investments but have re-emerged as the core anchor for risk appetite and profit expectations in U.S. stocks.

Asset management giant BlackRock's stock strategists have also shifted back to "overweight" U.S. stocks. BlackRock emphasizes the upcoming earnings season for U.S. stocks, asserting that the profit growth engine can support the main theme of the U.S. stock bull market. The strategists wrote, "Even during geopolitical conflicts, corporate profit expectations continue to rise, largely due to the strong demand for AI computing driven by AI-related investment themes."

In summary, the narrative of the new bull market in U.S. stocks is fundamentally supported by three major logics: the corporate profit resilience highlighted in the latest earnings season, the warming of risk appetite dominated by technology stocks/AI computing themes, and the market's judgment that the impact from the Middle East will not evolve into a long-term inflation scenario like in 2022. As long as these three pillars of logic remain intact, the U.S. stock market is expected to continue to strengthen against the backdrop of easing tensions in the Middle East