Inflation, Israel and Iran Dominated Last Week’s News

Commentary

Inflation continues to disappear, but the Fed doesn’t seem to believe the data yet. The Federal Open Market Committee (FOMC) meets today and tomorrow. If they don’t cut their key interest rate this week, they should at least announce their intention to cut during their next meeting (July 29-30).

The biggest news last week was Israel’s massive air strike on Iran’s nuclear production facilities, missile bases, and other key sites. As a result, gold and energy stocks are expected to remain an oasis. Bond yields worldwide will also likely meander lower as the threat of war in the Middle East spreads and the Strait of Hormuz closes.

You also may have noticed that small-cap stocks are doing well this month. That’s because June is the time for Russell’s annual index realignment. Every Friday in June, Russell announces its proposed 1000 and 2000 index changes. (The Russell 3000 is the Russell 1000 and 2000 indices combined.) The stocks that are added to both the Russell 1000 and 2000 indices naturally benefit from index accumulation, and many institutional managers like to “track” these indices. After Friday, June 27, the Russell realignment will be finalized, and many stocks being added to Russell indices will likely “pop” on Monday, June 30th.

Here are the most important developments recently and what they mean:

– The fact that some Iranian missiles are getting through Israel’s Iron Dome and causing horrific civilian damage may draw the U.S. into the conflict, especially since the U.S. has B-2 stealth bombers stationed in Diego Garcia that can carry up to two bunker buster bombs per plane. Israel’s biggest challenge remains taking out Iran’s most fortified nuclear facility, Fordow, where Iran produces highly enriched uranium. Many military experts believe Fordow, which is built deep into a mountainside near Iran’s holy city of Qom, could only be destroyed with a massive bunker-busting U.S. bomb from a B-2 stealth bomber. In the meantime, Israel continues to kill more Republican Guard leaders as well as reportedly six nuclear scientists.

– The Trump Administration is still trying to negotiate with Iran rather than join the conflict. It was reported that Iran has been urgently signaling that it seeks an end to hostilities and resumption of talks over its nuclear programs, sending messages to Israel and the U.S. via Arab intermediaries, according to Middle Eastern and European officials. In the meantime, the G-7 meeting in Alberta this week has poor timing, since President Trump has his hands full monitoring the ongoing situation. Israel’s El Al airline has canceled all flights through June 19th and most flights through June 23rd, which is consistent with the fact that IDF operations are expected to last up to 14 days, and at the end, the IDF said, “There will be no nuclear threat.”

– Speaking of the G-7 meeting in Alberta, Indian Prime Minister Narendra Modi was invited by Canadian Prime Minister Mark Carney. Previous Canadian Prime Minister Trudeau accused Modi’s government of backing the murder of a Sikh activist in Canada in 2023, which led to a deep rupture in Canada’s relations with India. Saudi Arabia’s Crown Prince Mohammed bin Salman was also invited, along with Mexican President Claudia Sheinbaum, as well as the leaders from Australia, Brazil, South Africa, South Korea, and Ukraine. In other words, Prime Minister Carney is turning the G-7 into a bigger event than normal but is not calling the meeting the G-15.

– The Federal Open Market Committee (FOMC) statement on Wednesday will also be crucial. I am expecting a dovish FOMC statement due to a weak Beige Book survey (in 9 of 12 Fed districts) and better-than-expected inflation results in the past four months. I do not expect the retail sales report on Tuesday to influence the Fed, but I hope the FOMC statement will refer to better-than-expected inflation news rather than anticipating an inflation “bogeyman” that has not materialized.

– The Commerce Department announced that retail sales declined 0.9% in May and June’s retail sales were revised lower to a 0.1% decline (down from a previously reported 0.1% increase). This is the first time that retail sales have declined for two consecutive months since late 2023. Fully 7 of the 13 retail sales categories surveyed declined in May, led by building materials, gasoline and vehicle sales. Also concerning is that sales at bars and restaurants in May declined 0.9%, so consumers were out and about less. The only silver lining was that, excluding building materials, gasoline and vehicle sales, core retail sales in May rose 0.4%. Treasury yields declined in the wake of the May retail sales report, which is putting more pressure on the Fed to cut key interest rates.

Overall, geopolitical risks remain high, with the Ukraine/Russia situation unresolved, and the Middle East situation always hard to consider stable. The “No King” protests this weekend in the US, while more peaceful than feared, showed domestic tensions remain. Nevertheless, investors have been reminded that geopolitical risks are almost always more bark than bite.

*Views expressed in this article are opinions of the author and do not necessarily reflect the views of The Epoch Times.