Peak tariff uncertainty and geopolitical risk appear to be winding down. The growth-inflation mix in the second half of the year will still be pressured, but risks are shifting away from the downside. The complication is that policy is responding to where inflation has been, not where it is now heading. Both the ECB and the Bank of Japan have raised rates, and the Fed and the Bank of England maintain a hawkish stance. For a sector whose earnings are levered to the rate curve and to credit conditions, the central story of the quarter is the gap between a backwards-looking policy reaction function and a forward-looking improvement in the shock environment.
On trade, the US Supreme Court's decision to cancel two-thirds of the ‘Liberation Day’ tariffs removed them from sole presidential discretion. The emergency Section 122 replacement (10%, with a threat of 15%) has itself been struck down by a limited trade court ruling and, in any case, will expire. By mid-July, shortly before the midterms, it falls to Congress to extend Section 122, or the US government will pursue the broader Section 301 measures now under investigation. Left to expire, the average effective tariff would fall from nearly 20% at its peak to around 8%. While this is still three to four times the pre-2025 norm, it is far more manageable and enough to ease the scepticism that had built around flows into the dollar and US assets – the bedrock of global portfolios.
On energy, the 17 June US-Iran memorandum to end the war promised to reopen the Strait of Hormuz and lift the naval blockade, with sanctions relief and oil-export relief to follow over a 60-day window. The inflation path will be materially affected. May's US 4.2% print was overwhelmingly an energy function: energy prices rose 23.5% year-on-year and gasoline over 40%, while core inflation, at 2.9%, was already cooling on a monthly basis to 0.2%. With Brent down some 30% from its c.$115 conflict peak, the single largest driver of the surge is now reversing; Oxford Economics judges that May likely marked the headline peak. The contrast with the prior quarter is stark: three months ago, the binding question was how long the Strait would stay closed. Now it is how quickly the disinflation that follows its reopening feeds through supply chains.
The principal offset is monetary, especially at the Fed in its role as the world's most important central bank. At Chair Kevin Warsh's first meeting on 17 June, the Fed held at 3.50-3.75% but turned hawkish: the median 2026 dot was lifted to 3.8% from 3.4% in March, flipping the signal from one cut to one hike. Nine of eighteen participants now expect an increase and seventeen judging inflation risks to the upside. The easing bias was dropped. This pivot is anchored on an energy-driven spike that the peace deal is simultaneously unwinding. For markets, that argues for resilient earnings and contained recession risk, but caps the multiple expansion that a cutting cycle could have delivered. For balance sheets carrying long-duration assets, it is the source of the quarter's principal asymmetry.
The growth-inflation mix in the second half will still be pressured, but risks are shifting away from the downside. Uncertainty has been the binding constraint on investment and hiring; its removal may release upside that the consensus, conditioned by two quarters of bad news, is slow to price in. We continue to frame this within our 3D themes: Debt, Disruption and Deregulation, and a world undergoing significant geopolitical and geoeconomic reorientation. The fading of both shocks does not end that reorientation; it simply lowers the near-term tail. Our central case is therefore one of contained recession risk and resilient corporate earnings, with the dispersion of outcomes narrower than at any point since the turn of the year.
We see the end of the Iran war as the dominant positive for the outlook, and our base case is that its inflationary footprint is now in retreat. After a quarter of disruption, the 17 June memorandum reopens the Strait and lifts the blockade, with relief phased over a 60-day window; oil prices have already done much of the adjustment, with Brent some 30% off its c.$115 peak. We would treat the path from here as a normalisation: trading activity, not only fundamentals, drove price rises and should also drive them down, albeit at a measured pace. Risks are still there, of course, but in our central case, the energy shock is fading and with it the single largest source of upside surprise to headline inflation.
The Supreme Court's ruling reaffirms the rule of law and, just as importantly for our sector, removes tariffs from sole presidential discretion. We expect policy to remain fluid and uncertainty around existing treaties to persist, but the trajectory remains downward. This should be overall positive for the economy and, in turn, for earnings in the financial sector.
The hawkish hold is the principal complication, not the principal threat. The flip from one cut to one hike is anchored on an energy spike that the peace deal is unwinding. In our view, the data are likely to soften the case for hikes as the year progresses, even if the Fed is unwilling to pre-commit. We read the reaction function as hawkish but unanchored: responsive to realised inflation yet reluctant to look through a shock that is already reversing. For financial services, this is, on balance, supportive. A higher-for-longer plateau is more valuable to the sector than a rapid return to the lower bound, provided the hawkish ‘signal’ does not become a hawkish ‘act’.
With central banks adopting a more hawkish stance, financial services could benefit more than other sectors. A higher-for-longer rate is likely to sustain net interest margins for banks and lift reinvestment yields for insurers. Equally, lower oil prices and reduced trade uncertainty could improve credit quality across the board. Assuming the 17 June US-Iran memorandum stands, the reopening of Hormuz will eventually normalise marine insurance and trade-finance pricing, unwinding the war-risk premia that inflated cargo and hull rates through the first half. Receding policy uncertainty typically revives capital markets activity, supporting M&A and issuance fee income; a swing factor for diversified banks after several muted quarters. In short, the same backwards-looking policy that frustrates rate-sensitive borrowers is, for much of the sector, a tailwind: the plateau preserves the deposit-repricing benefit on the asset side, while the fading shocks repair the credit side.
The principal caveat is duration risk. Should hawkish intentions translate into actual hikes, unrealised losses on bank and insurer bond portfolios could resurface as a tail risk, as 2022-2023 demonstrated. This is the scenario we watch most closely, precisely because it runs against the grain of an improving macro picture: a Fed that hikes into a disinflationary energy reversal would be reacting to the past at the expense of the present. Any renewed back-up in yields would crystallise mark-to-market losses on portfolios still carrying the legacy of the last cycle. In the US, unrealised losses are still roughly 50% off their peak, in the order of $300–400bn. In Europe, where they peaked at €124bn on ECB data, we would expect something close to half that figure to remain. A 2022-style hiking race would weigh on balance sheets and profitability well beyond the immediate benefit. For us, this remains a tail-risk scenario, not the base case, but it is the one contingency in which the sector's positive operating leverage to higher rates inverts.
The private-credit stress that dominated the previous quarter has not disappeared, but the improving rate and recession backdrop ease it at the margin. Contained recession risk and a peak in borrowing costs reduce the refinancing pressure on the most leveraged borrowers, particularly the software and technology names most reliant on private financing. We continue to see the asset class as something to monitor rather than to fear. At roughly $1.5tn, it is small relative to $150tn in equities and a comparable stock of fixed income, with an estimated $100–225bn of assets considered at risk and exposure of around 7.5–8.0% of aggregate bank loans. European banks remain lightly exposed, typically below 1% of total assets and well enough capitalised to absorb an isolated shock. Our concern, as before, is less direct European exposure than US bank linkages and the opacity of interconnections. It’s a concern that recedes but does not vanish as financial conditions ease.
This is the first quarter since the turn of the year in which the dominant risks to financial services point up rather than down. The base case is a constructive one: margins supported by a higher-for-longer plateau, credit quality repaired by cheaper energy and lower trade friction, and fee income revived by the return of risk appetite. The asymmetry sits entirely in duration: a Fed that mistakes a fading shock for a persistent one and hikes into the reversal. While we would size that as a tail, not a central case, it is the single variable capable of changing the sector's otherwise improving outlook.
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