Iran De-Escalation Calms Markets, Inflation Complicates Fed Outlook
Investors enter the final day of the week on a bit of a high after a roller coaster week for equities.
The S&P 500 and Nasdaq-100 are now positive as of Thursday’s closing price. The positive sentiment came after stocks surged on Thursday on President Donald Trump’s announcement that planned military action against Iran had been called off. The decision eased fears of a broader military escalation and helped trigger a sharp rebound in growth stocks and semiconductors after several sessions of pressure.
The relief was certainly logical as no immediate U.S. strike lowered the odds of a worst-case oil shock and gave investors room to cover shorts in some of the week’s hardest-hit areas. However, the market response could be viewed as a positioning rebound, not an all-clear signal. The CBOE Market Volatility Index (VIX) remained above 20 despite Thursday’s rally, showing that traders still wanted near-term protection. The VIX was lower Friday morning.
If the Iran de-escalation holds and shipping risks in the Strait of Hormuz continue to fade, crude could remain under pressure, and growth stocks could extend the bounce. If diplomacy fails, the same inflation fears that pressured markets earlier in the week could quickly return.
Commodities showed how much risk premium had already come out of the market. Over the past five trading days, the U.S. WTI crude benchmark fell 5% but a late week rally put a bid back into gold, silver and copper. The dollar index also softened, while the 10-year Treasury yield fell about 31 basis points to roughly 4.46%. Transports were a bright spot, rising over 2%, while defensive sectors led the market. Consumer staples and healthcare outperformed, while communication services, information technology, consumer discretionary, and energy were the weakest groups.
Inflation data keep the Fed in a difficult position. May CPI rose 0.5% for the month and 4.2% from a year ago, up from 3.8% in April. Core CPI was more reassuring, rising 0.2% for the month and 2.9% year over year. But energy did most of the damage: the energy index rose 3.9% in May and 23.5% from a year ago, while gasoline rose 7.0% on the month and 40.5% year over year. Outside of energy, the report was less alarming. Shelter rose 0.3% in May and 3.4% from a year earlier, while food prices increased 0.2% on the month and 3.1% year over year.
The PPI data added to the concern over upstream inflation pressure. Final demand prices rose sharply in May, with goods inflation and energy costs doing much of the work. The key issue for markets is whether companies can absorb higher raw material, fuel, and logistics expenses without passing them through to consumers. If they cannot, the recent energy shock could keep headline inflation elevated for longer and complicate the Fed’s policy path.
That sets up a tense Fed meeting next week. The June FOMC meeting includes updated projections, and the relationship between the fed funds rate and the 2-year Treasury yield is becoming more important. With the 2-year yield trading above the current policy rate, the front end of the curve is no longer signaling a clean path toward cuts. Instead, it reflects sticky inflation, firm nominal growth, and the possibility that the Fed may need to stay restrictive longer than investors hoped.
Earnings reinforced the AI tension. Oracle (ORCL) reported strong revenue growth, helped by cloud infrastructure and AI-related demand, but the stock fell as investors focused on heavy capital spending, negative free cash flow, and the rising cost of building data-center capacity. The reaction showed that investors still like the AI theme, but they are becoming more selective about companies that need to spend aggressively before translating AI demand into durable earnings and cash flow.
Overall, the late week rally improved sentiment, but it did not fully repair the damage from a volatile five-day stretch. Inflation remains too firm for the Fed to sound dovish, geopolitical risk is still capable of moving oil and rates quickly, and AI-linked stocks are facing more scrutiny after a powerful run.
