Yanni Angelakos, Head of Investment Insights, Nasdaq Capital Access Platforms
Key Points:
- Financial markets’ fading Middle East risks and potential U.S. trade agreement developments have pushed cross-asset volatility lower.
- As equities set new highs, investors look to Q2 earnings season amidst elevated valuations.
- Markets pricing in up to three Fed rate cuts in 2025 plus ongoing U.S. fiscal policy and deficit concerns are contributing to the largest USD decline in the first half of a year since 1973.
Summary
Continuing with the theme of equity resiliency from our prior piece, against the backdrop of the Middle East conflict, U.S. equities have made new all-time highs. Risk assets have sidestepped this latest fissure in the geopolitical landscape as market volatility has quickly receded given indications that the truce between Israel and Iran is holding. Yet this serves as a reminder that the world has entered a regime of increased macro volatility and that top-down uncertainties are likely to persist. Markets are awaiting more details regarding the U.S. and China finalizing a trade understanding, and whether the U.S. will reach agreements with other major trading partners ahead of the end of the 90-day tariff pause on July 8th—a dynamic which continues to inform the Federal Reserve’s outlook. Investor focus will next turn to Q2 earnings season for a bottoms-up read of the corporate and consumer environment amidst elevated U.S. equity valuation levels while the USD is experiencing a historic decline.
Biweekly Chart in Focus: Cross-Asset Market Volatility Has Receded
Source: Bloomberg. Notes: weekly intervals as of 6/27/25.
Details
U.S. Equities Back to New Highs as Market Volatility Subsides
As Middle East developments escalated, the markets focused on oil price swings on concerns around potential supply disruptions. Brent crude oil spiked to a five-month high but then dropped by nearly 15% just as quickly as the situation de-escalated.
Oil volatility hit its highest since the outset of the Ukraine war in March 2022 before receding. S&P 500 Index equity volatility (VIX) has fallen to around 17 and is below its five-year average of 20, and Nasdaq-100 Index® (NDX®) volatility (VXN) of around 19 is similarly below its five-year average of nearly 25. These moves are reflected in our biweekly chart in focus above showing volatility measures across oil, equities, and Treasurys on a z-score basis. There is the risk, though, of near-term market complacency given expectations that equity volatility will resurface.
Regardless, both the Nasdaq-100 and the S&P 500 Index set new all-time highs the last week of June. The latest positive macro catalyst for risk assets is news that the U.S. has reached a trade agreement with China and other major trading partners. Investors are also monitoring the progress of the administration’s tax and spending bill which would extend the 2017 tax cuts. And while the situation remains precarious in the Middle East, markets are pricing in that this conflict will be contained and tracking the historical trend of these events tending to be episodic. Per Morgan Stanley, the median return for equities three months forward is +4.1% post key global military conflicts since the Korean War.
Q2 Earnings Season as the Next Micro Catalyst
The markets will remain preoccupied by trade policy developments ahead of July 8th and geopolitical volatility amidst the shifting backdrop—macro dynamics, in all reality, which very few have an edge on. Investors will likely breathe a sigh of relief to be able to pivot to Q2 2025 earnings which unofficially kick-off on July 15th.
Downward revisions to earnings estimates coupled with negative EPS company guidance have pushed the S&P 500’s estimated earnings growth for Q2 to 5% YoY versus 9.3% YoY on March 31st, which would be the weakest since Q4 2023 (per FactSet). While analysts’ earnings estimates have been revised lower by a greater margin than average (-4.1% thus far versus the five-year average of -3%), the percentage of companies issuing negative EPS guidance for Q2 is slightly below average (FactSet). Of those S&P companies which have issued Q2 EPS guidance, 54% have issued negative EPS guidance relative to the five-year average of 57%. Thus far, a more aggressive negative guidance cycle given the angst around the potential impacts from trade tariffs has not materialized—a still present risk which the markets are not currently pricing in.
FedEx, a key economic bellwether, did not provide a full-year forecast in its fiscal Q4 earnings report on June 25th due to the “uncertain global demand environment”—the only time in the last 13 years. A reminder that although the trade tariff conflict has de-escalated since early April which has helped underpin risk assets, ambiguities will persist until corporates and consumers have more clarity on actual rates and timelines.
Heading into earnings season, U.S. equity valuations remain elevated as the Nasdaq-100’s and S&P 500’s next twelve-month price to earnings (P/E) ratios are currently at a 42% and a 39% premium, respectively, relative to their 20-year medians (as of June 27th). However, lofty valuations for U.S. equities are not new and have not hindered them to vastly outperform the past two years. And despite the lingering macro uncertainties, the potential for the AI theme to further drive U.S. corporate innovation, and profitability and free cash flow growth has broadly justified these elevated valuations.
While U.S. companies being at the forefront of the AI revolution has afforded them these richer valuations, most international equity indexes, such as Europe’s, have not had the same luxury. Consequently, MSCI U.S.’s next twelve-month P/E is at a 47% premium relative to MSCI Europe ex-UK—well above the long-term median premium of nearly 17% (since January 2006) and has been part of the thesis for investors seeking opportunities in European equities.
Federal Reserve Developments and U.S. Fiscal Deficit Concerns Leading to Historic USD Weakness
Based on the last Fed meeting on June 18th and Chair Powell’s press conference, the market view is that the Federal Reserve is increasingly focused on softer labor markets (e.g., four-week moving average of initial jobless claims hit their highest since August 2023) and ongoing housing market concerns. Yet it is mindful of inflation remaining sticky given potential pass-through effects from tariffs.
The Fed’s “dot plot” from its June 18th meeting is still calling for two 25bp rate cuts in 2025 with the markets now pricing up to three and the first one in September. Markets are only pricing in around a 21% chance of a cut at the July 30th meeting, though up from 10% post its last meeting, after some Fed members came out in support of a rate cut in July. However, others have indicated that more time is needed given clouded outlooks, consistent with Fed Chair Powell’s semi-annual testimony to Congress where he reiterated that they are in “wait and see” mode.
Fed rate cut expectations coupled with U.S. fiscal policy and deficit concerns, and speculation around the next Fed Chair, have CFTC positioning showing the largest USD net short exposure in four years amongst the speculative investment community (e.g., hedge funds, CTAs). In tandem, the broad-based USD index (DXY) is at its lowest since February 2022. It experienced its weakest first half of a year (-11.4%) since 1973 following the end of the Bretton Woods system amidst the USD devaluation and the oil shock from the Arab-Israel War which began an inflationary spike and weakened the USD.
Emerging market (EM) assets tend to benefit from a weaker USD as, amongst other factors, 1) they can attract capital as investors seek higher returns elsewhere and 2) EM bonds denominated in USDs cost less to service. The iShares MSCI Emerging Markets ETF (EEM) had its best first half of a year (currently +15.5%) since 2017, the last time there was prolonged USD weakness. USD concerns have also benefited gold which is higher by nearly 24%—largest first half gain since 1973—and Bitcoin in its evolution as a storer of value as it is higher by 13.5% YTD.
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