The bull market faces higher likelihood of a Fed rate hike as Iran crisis intensifies

By Joy Wiltermuth

Treasury yields are approaching the highest levels seen since the Iran war started as oil price rise and odds of a Fed rate hike narrow

The bull market in stocks would turn 4 in October, but the Iran war is looking like a stumbling block.

The bull case for stocks suddenly looks more fragile as the Iran war intensifies, oil prices rise and anxiety builds in the U.S. bond market about possible Federal Reserve rate hikes.

Tech stocks have been the main driver of the bull market as its four-year anniversary nears in October. Pockets opened up when the rally expanded beyond tech, signaling an economic backdrop and a healthier bull market that could last longer.

Yet a look at the S&P 500's equal-weight index XX:SP500EW below shows performance has lagged when a portfolio misses out on the outsize influence of tech megacaps.

Now investors must navigate global oil prices (BRN00) back to pre-ceasefire levels above $93 a barrel and benchmark 10-year Treasury yields BX:TMUBMUSD10Y at 4.65%, near their highs in May, some three months after the Iran war began.

Higher yields make it more expensive for the government, businesses and households to borrow. The 30-year Treasury yield BX:TMUBMUSD30Y on Wednesday was on the cusp of having held above 5% for its longest stretch since 2007. Like higher oil prices, elevated rates can cool consumption and chill the economy.

Adding to the angst, President Donald Trump on Wednesday threatened to use the U.S. military to bomb Iranian bridges and power plants if the Iranian regime shoots at ships in the Strait of Hormuz.

"Oil prices are leading interest rates up," said Keith Lerner, chief investment officer at Truist Advisory Services. Those two factors "complicate the Fed story," he said, adding that the chance of a rate hike at next week's U.S. central bank meeting were edging higher.

The likelihood of a Fed interest rate hike this month, based on the trading of fed-funds futures, was as high as 33.7% on Wednesday, before easing slightly to 31.5%, according to the CME FedWatch Tool. That's up substantially from 25.7% on Tuesday. That might signal that a rate hike isn't exactly likely, but the odds are not moving in the right direction, Lerner said.

Fed Chairman Kevin Warsh told Wall Street in June to stop relying on the central bank to telegraph its every move in advance. Wall Street has come around to the idea by treating future Fed meetings as "live" in terms of potential interest-rate adjustments.

"I think it would be counterproductive to [raise rates]," said Robert Pavlik, senior portfolio manager at Dakota Wealth Management. "A lot of Wall Street thinks they will, but I think [it would be] a mistake."

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Higher interest rates can weigh on highflying tech stocks XX:SP500.50 and rate-sensitive parts of the stock market, like the small-cap stocks tracked by the Russell 2000 index RUT, which was down 0.8% Wednesday. The S&P 500 SPX was slightly negative at 7,504.

The U.S. economy also could struggle to reaccelerate beyond the artificial-intelligence spending boom. Higher rates tend to hurt struggling lower-income households the most, especially with gas prices at the pump having reclaimed $4 a gallon as the U.S.-Iran ceasefire evaporated.

Gasoline prices still may reach $4.15 to $4.25 a gallon in the next few weeks, according GasBuddy's Patrick De Haan.

"Our view has been that the bull market trend is still intact," Truist's Lerner said. Yet he also expects a choppier period after July, he said, with "some of these risks that seemed like they were going away [instead] reappearing."

The AI hyperscalers will need to deliver on earnings, including Alphabet (GOOGL) (GOOG), which reports quarterly results Wednesday after the bell.

"The whole market is fixated on AI and the rotation," said Pavlik at Dakota Wealth. But with rates heading "in the wrong direction, as far as the market and economy is concerned," but an easy solution is elusive.

"We started a war with Iran," Pavlik said. "And we have no exit strategy."

-Joy Wiltermuth

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