Risk premium recedes, but geopolitical risk returns

Summary

Last week in markets 

Markets ended the week on a more cautious note. Lower oil prices eased inflation concerns, but weakness in technology and AI-related stocks weighed on broader equity performance. The S&P 500 declined 1.94% on a total return basis, falling from 16,772.64 on June 18 to 16,447.29 on June 26. The Nasdaq dropped 4.6% as investors reassessed whether earnings growth can continue to support elevated AI valuations.

Treasury yields moved lower as concerns over energy supply eased, although inflation remained too elevated for the Federal Reserve to shift its policy stance. The 10-year Treasury yield ended Friday at 4.38%, down from 4.51% on Monday. Brent crude settled at $72.60 per barrel, down from $77.52, as improving tanker traffic through the Strait of Hormuz and an interim diplomatic framework reduced the market's geopolitical risk premium.

Inflation, however, continues to argue for patience. May PCE inflation increased 4.1% year over year, while core PCE rose 3.4%, reinforcing expectations that the Federal Reserve will maintain a cautious approach to easing policy.

The geopolitical backdrop shifted again over the weekend. Iran launched drone and missile attacks targeting Bahrain and Kuwait following new U.S. strikes on Iranian military assets. Tehran also threatened to suspend negotiations if U.S. military action continues and reiterated its intention to oversee the reopening and operation of the Strait of Hormuz.

For markets, the key question is whether last week's decline in oil prices reflects a lasting improvement in supply risk or a temporary reprieve before geopolitical tensions once again drive higher energy prices, inflation expectations, and market volatility.

The week ahead 

Attention now turns to the labor market.

Tuesday brings JOLTS job openings and consumer confidence, followed by ADP employment and the ISM Manufacturing Index on Wednesday. The June Employment Situation report will be released Thursday, with investors focused on payroll growth, unemployment, and wage gains after May payrolls increased by 172,000 and the unemployment rate held at 4.3%.

The labor data will help shape expectations for Federal Reserve policy. A resilient labor market would reinforce the case for keeping rates higher for longer, while softer employment data would suggest that restrictive policy is beginning to slow economic activity.

Central bank communication will also be in focus. The ECB Forum on Central Banking begins June 29 in Sintra, where investors will monitor comments from Christine Lagarde, Andrew Bailey, Tiff Macklem, and Kevin Warsh for signals on the global policy outlook. With the Federal Reserve's next policy meeting not scheduled until July 28-29, public remarks from policymakers will play a larger role in shaping market expectations. Investors will listen for any indication that officials intend to push back against the recent easing in financial conditions following lower oil prices and declining Treasury yields.

Geopolitics remain the primary source of tail risk. Although improving shipping conditions have reduced immediate concerns around energy supply, the Strait of Hormuz remains a critical pressure point for global energy markets, inflation expectations, and investor sentiment. With U.S. equity markets closed Friday for the Independence Day holiday, lighter trading volumes could amplify market reactions to Thursday's employment report.

Rather than focusing on a single economic release, investors should be assessing whether lower market risk premiums can withstand another test from labor data, central bank messaging, and an increasingly uncertain geopolitical backdrop.