U.S. stocks seen absorbing end of Fed easing cycle amid inflation risk

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Highlights

Fed funds futures now assign a 50% chance of a rate hike at the October meeting and 79% by December, driven by persistent inflation signals.
Cleveland Fed's two-year inflation expectations remain below the 2022 high of 2.98%, reducing the likelihood of severe Fed tightening seen previously.
Nasdaq-100 continues to outperform, and a breakout in growth shares may occur if inflation stays contained and Fed policy turns less hawkish.

Inflation signals and rate path outlook

As reported by CNBC, the latest market debate centers on whether elevated inflation readings and geopolitical pressure from the Iran war are enough to push the Fed from holding rates steady to tightening again later this year.

Recent consumer price index and producer price index data are elevated, with price pressures extending beyond energy into core measures that exclude food and energy. Housing costs are also contributing to that firmness, adding to concerns that inflation is not easing quickly enough.

CME Group fed funds futures indicate a sharp shift in expectations over recent weeks. Where markets had previously assigned almost no probability to a quarter-point increase to 3.75% to 4.00% from the current 3.50% to 3.75% range by year-end, pricing now implies a 50-50 chance of a hike at the October meeting and a 79% chance by December.

The analysis argues, however, that the inflation backdrop still looks less severe than in 2022. Two-year expected inflation from the Cleveland Fed remains below its 2022 peak, suggesting the kind of breakout that previously drove sharp moves in Treasury yields and the Fed funds rate has not yet been repeated.

Growth trade resilience and market implications

The outlook for equities remains tied to whether expected inflation stays under control. If Middle East tensions de-escalate and two-year inflation expectations remain below the 2022 high of 2.98%, the case for rate hikes in 2026 weakens and the growth trade could continue to outperform.

The Nasdaq-100 is still advancing strongly, led by hardware and semiconductor shares, although the ratio of growth to value stocks, measured through VUG/VTV, is showing a moderate divergence that raises a limited warning flag. Even so, a longer-term chart of the Nasdaq Composite to S&P 500 ratio suggests growth shares are testing a major resistance level for a third time, a pattern that technical analysts often view as setting up a breakout.

On that view, further clarity on inflation and a less hawkish Fed stance could direct more capital into the AI-led growth trade and support broader gains across the U.S. stock market. If inflation expectations climb further instead, investors may need to adopt a more defensive posture similar to the one used in 2022.

In our earlier coverage of the EU’s fertiliser-cost shock tied to the Iran war, we explained how disruption around the Strait of Hormuz pushed up fertiliser and gas prices and prompted Brussels to prepare emergency support for farmers. That report outlined potential measures such as strategic stockpiling, looser short-term aid and advance CAP payments, while warning that higher input costs could ultimately filter into food prices.

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