May 18th, 2026

“A gem cannot be polished without friction, nor a man without trials”

Confucius

After a successful an apparent summit in China, the results need to be seen in the markets. Here are the numbers, despite new highs, basically a volatile week ending with the selloff last Friday. The S&P 500 gained .18%, the Dow Jones Industrial Average was off a slight .17%, the Nasdaq was flat off .08%. Internationally, the FTSE 100 lost .375 and the MSCI-EAFE surrendered 2.1%. The 2-Year Treasury paid 4.082% and the 10-year yield was 4.595%.

So, what happened and why is the market still moving to new highs? Nearly three months into the Iran war, Americans are still spending plenty of money to keep the U.S. economy on the up and up. Some signs of stress have emerged, but not enough to suggest a major stumble. The latest evidence on consumer spending (the main engine of the economy) shows little or no pullback in household purchases since the Iran conflict began at the end of February. Stable consumer spending, plus a big surge in business investment in artificial intelligence, could lead to robust second-quarter growth based on the official scorecard for the economy known as gross domestic product. It’s still early in the cycle, but the Atlanta Federal Reserve’s GDPNow forecasting tool predicts 4% growth in the second quarter, double the 2% increase in the first three months of the year. This resulted in markets being mostly higher this week as investors focused on strong earnings that are keeping the AI trade rolling along. Investors also remain confident that an end to the blockade in the Strait of Hormuz is coming sooner rather than later. That would take the pressure off inflation, which came in hotter than expected on both the consumer and producer levels. Sticky inflation is changing the outlook for rate cuts and is even putting the idea of a rate hike on the table. For now, however, investors are buying into the growth story, which is backed up by mostly solid earnings. That outlook may be tested next week when the major retailers report.

What has been the big winner so far? Small caps, represented by the Russell 2000 index, were up 12.6% year to date, but fell 2.4% on Friday due to rising Treasury yields. Small-cap outperformance was supported by improving earnings and a rising forward-to-earnings ratio, now 11% above the average. Many small-cap companies are integral to artificial-intelligence infrastructure, though a stable macro environment is needed for sustained growth.

Interest Rates, Bonds, and Inflation?

That collection of anxieties contributed, as mentioned, to the yield on 10-year Treasuries to surge to 4.595% today, and the yield on 2-year notes jumped to 4.082%. Markets appear to be realizing that hopes of a Fed interest rate cut later this year might be misplaced, and in fact there could even be an interest rate hike. The nature of the markets is that there is always something to worry about.  A few weeks ago, it was oil prices, now it’s rising interest rates. It’s particularly notable that the yield on the 30-year Treasury is now well above 5%, the highest level since 2007.

As expected, the Senate confirmed Kevin Warsh as the next Federal Reserve chair on a 54-45 vote, replacing Jerome Powell, with Sen. John Fetterman, D-Pa., the only Democrat to cross the aisle. Into this multi-level mix steps Kevin Warsh, the newly approved Chairman of the Federal Reserve. Susan Collins, president of the Fed’s Boston branch, set the tone on Wednesday when she said she could “envision a scenario” where the US central bank would need to raise interest rates to combat the surge in inflation.  She then engaged economist double-speak by noting that this was not her “baseline” view. Now we will see how the new FED chair handles the discord in the group. Kevin Warsh’s tenure as Federal Reserve chair begins amid heightened market scrutiny as investors grapple with renewed inflationary pressure. Not to mention a resident of 1600 Pennsylvania Avenue looking for rate cuts.

Bottom line? Stronger than expected April CPI (Inflation) reinforces the case for patience, even as the new chair has expressed comfort looking through one‑off price pressures. However, the Fed’s consensus decision making structure and the drift of core inflation away from target both suggest policymakers may hold off on cuts and keep policy unchanged longer than anticipated. For investors, the risk is rising that it will be 2027 before they see any further policy easing from the Fed.

Add to that, the economy got a lift recently from bigger tax refunds and lower tax rates. (Big Beautiful Bill) That helped consumers to cope with surging gas prices. The tax benefits are already fading, though, and the higher cost of energy is working its way through the economy. U.S. growth could suffer if the situation persists for a prolonged period. Once the Iran war is settled and the promised drop in gas price should be very good and welcome news for consumers. But the biggest cushion for the economy might be the stock market rally. Richer families tend to spend more (the so-called wealth effect) when their stock portfolios and retirement funds increase sharply.  Tell that to the average American just trying to get to work, relief is needed and hopefully will not have to long to wait. The wild card? Iran still seems to think it can wait out the President.

So going forward, the focus remains on inflation trajectory, Federal Reserve path under new leadership, oil supply developments, and upcoming earnings (e.g., NVIDIA). Volatility is likely to persist. The good news is so far 2026 has been rewarding for investors. The bad news is mortgage rates and the housing market, as 30-year mortgage rate rose again last week to over 6.65%, but new applications were up 4%, when will home buyers get a break? Only the FED knows for sure.

Mike