We started July with a wonderful 250th birthday celebration for our great country, but the geopolitical environment became highly uncertain throughout the remainder of the month. This uncertainty pushed rates higher and took the stock market on a round-trip ride down, then back up.

After much optimism about the potential peace agreement with Iran, July brought a breakdown of negotiations and more strikes in the region. Oil shot back up to $100/barrel (Brent) and the stock market pushed lower. Additional uncertainty came from another round of very light communication from Fed Chair Warsh. The Fed remained on hold after their meeting near month end, and the post-meeting comments from Warsh provided little guidance regarding the policy outlook. This is consistent with his pledge to deliver less forward guidance, but it left the markets to figure out how to deal with significantly reduced levels of communication from the Fed chair. CPI was better (lower) than expected in July, and personal consumption expenditures (PCE) was right on target.

After a rollercoaster ride for the month, the S&P 500 finished slightly lower in July as market focus shifted from AI demand to return on investment (ROI), which triggered a sharp reversal of momentum for semiconductor and memory manufacturers. But even with a sharp unwind in some of these AI stocks, overall earnings continue to impress, and the rest of the market continues to improve.

Second quarter S&P 500 earnings per share (EPS) growth is currently tracking at the fastest growth rate since 2021. While the reaction to positive earnings surprises has been lackluster for some sectors, the equal-weight S&P 500 has continued to climb alongside steady EPS growth. Additionally, tensions began to ease with Iran, and planned strikes were called off just as the month closed. Oil dropped to the low $80s and overall sentiment was improving as July ended. We remain hopeful that a long-term solution will emerge with Iran, but it’s hard to foresee us escaping the on-again, off-again cycle with the negotiations and attacks.

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Technical side note on the ‘term premium’

We’ve been talking for quite a while about how uncertainty is pushing interest rates higher and could keep them there for the foreseeable future. Academics refer to this as the “term premium” embedded in treasury rates. The term premium can be thought of as additional compensation (yield) required for increased uncertainty about forward policy. Of course, this would also encompass uncertainty about future inflation.

During the massive quantitative easing (QE) campaign following the pandemic (when the Fed purchased treasuries to push rates lower), the term premium was driven deep into negative territory, reflecting zero uncertainty about the direction of inflation and rates. However, as inflation came back to life and Fed policy was forced off zero, the term premium steadily climbed back to positive territory, moving even higher in 2026 as the Iran conflict cast uncertainty over the outlook for inflation. Additionally, Chair Warsh’s new policy of providing very little forward guidance exacerbates uncertainty, pushing term premia (and treasury rates) higher.

Higher rates

The 10-year treasury note has pushed back up to almost 4.70%, near the cyclical highs. Some analysts believe this is due mainly to a rising term premium. The Fed is sending tough signals regarding inflation, and forward guidance has all but disappeared (at least from Warsh). The combination of these two is almost certainly pushing term premia higher and taking treasury rates higher as well. We may be headed for a protracted period, with longer-term rates stuck in a higher range than we’ve been accustomed to for the last 15-20 years.

It could be said that recent trends simply represent the long-overdue normalization of rates. Term premia and treasury rates have risen, but only to the lower end of the range that prevailed during the decades before the Global Financial Crisis of 2008 (before the first wave of QE). We must remember that Warsh is quite overt in his criticism of QE. Looking back at the period before QE reveals a time when term premia and interest rates were at current levels or higher.

Markets adapting to new regime

Over the coming months, the stock and bond markets will have to adapt to a world with higher uncertainty and less clarity from the Fed. This could result in a world with higher overall rates and elevated volatility. These are not necessarily harbingers of doom, but merely new market realities that investors will need to be prepared to navigate.

Equity markets are well aware of these trends and have not been negatively impacted…yet. Earnings growth has been spectacular, more than offsetting any damage from higher treasury rates. At July month-end, the S&P 500 had posted a YTD total return of +10.12% — truly spectacular given the level of global uncertainty we’ve encountered. Consumption has been strong and GDP growth is holding steady, very near our long-term trend rate of 2.0%.

Despite the new issues arising in the macro-economic environment, we remain cautiously optimistic that GDP growth will remain steady and that earnings growth rates will be supportive of positive market returns over the next 12-24 months. We believe the Fed will remain on hold into early 2027, but this is highly debatable. In July, we removed our overweight to emerging market equities (having captured handsome excess returns), pushing back in favor of U.S. assets.

Summary and economic outlook

Investors should expect to see more topsy-turvy news around the conflict with Iran, and less guidance from the Fed.  We all need to be prepared to endure more volatile movements within the markets without any comforting commentary from the FOMC. Consumption and GDP growth should be sufficient to keep earnings grinding higher, supporting equity market returns as we head towards 2027.

Author: Eric Kelley serves as the executive vice president, chief investment officer for UMB Bank. In his role, he leads the bank’s economic forecasting team and sits on its asset liability committee as a voting member, helping to direct the company’s $68 billion balance sheet. In addition, he is responsible for the investment strategy for roughly $11 billion in client assets. Eric earned a Master of Business Administration from Baker University in Kansas City.