06.05.202609:59 Forex Analysis & Reviews: Market taps safety cushion

Good news from the Middle East allowed the S&P 500 to return to record highs. The White House said there had been no breach of the ceasefire and that Operation Epic Fury had concluded. Donald Trump reported progress in talks with Iran. The base case for the US equity market is now a near-term peace agreement between Washington and Tehran. A retreat in geopolitical risk allows the broad index to continue its rally.

Investors have been so focused on the Middle East conflict and on Q1 earnings that they have largely ignored fiscal stimulus. According to last year's large Trump tax plan, consumers will receive about $47 billion more in tax refunds in 2026 than in 2025, while tax receipts to the budget will fall by roughly $63 billion. That fiscal cushion for the economy supports a constructive outlook for the S&P 500.

The broad index is overlooking slowing service sector activity and the fact that PMIs' price components are near their highest levels since 2022 — a combination that signals growing stagflation risk. At the same time, the futures market is increasingly pricing in the chance of Fed tightening.

Dynamics of federal funds rate market expectations

High interest rates amid a cooling economy are a headwind for the S&P 500. And that's not the only challenge. The US index rallied strongly during the Middle East conflict, while the global MSCI barely advanced. JPMorgan argues that de-escalation could catalyze buying of undervalued European and Asian stocks. Capital rotating out of the US into other markets would remove a key engine from the S&P 500's rally.

In my view, fear is overblown. The US status as a net energy exporter means that the American economy is less exposed to high oil and gas prices than energy-dependent regions such as Europe or Japan. Meanwhile, the rhetoric from the European Central Bank and the Bank of Japan looks hawkish relative to that of the Federal Reserve. If Washington intends to hold monetary policy steady, Frankfurt and Tokyo keep talking about interest rate hikes.

So, belief in a resolution of the Middle East conflict, solid US corporate earnings, and Trump's fiscal measures support the continuation of the S&P 500's uptrend.

Technically, the broad index kicked off the new trading day with a gap up on the daily chart. Bears were unable to close the gap, indicating weakness. Under these conditions, it makes sense to focus on long positions in the S&P 500. Target levels for buy entries are 7,420 and 7,500.