by Patrick Fearon-Hernandez, CFA, and Thomas Wash

[Posted: 9:30 AM ET] | PDF

Our Comment begins with an assessment of recent business survey reports, including the ISM surveys and the Federal Reserve’s Beige Book. We then examine the rising political costs associated with the war in Iran. Next, we discuss European efforts to initiate peace talks between Russia and Ukraine, AI-related concerns following Broadcom’s weaker-than-expected outlook, and emerging risks in leveraged loan markets as delinquencies rise. As always, we include a review of recent domestic and international economic data releases.

Economic Resilience: Recent data suggests that AI-driven investment momentum continues to support growth. The latest Fed Beige Book and ISM Services survey indicate that the economy remained in expansion territory in May. Firms appear to be accelerating purchases in anticipation of potential supply disruptions linked to the Iran conflict, while AI continues to drive greater investment. While the headline resilience reinforces the view that the economy is absorbing geopolitical shocks, it also points to emerging risks beneath the surface.

• The May ISM Services PMI rose from 53.6 to 54.5, exceeding expectations of 53.8. The gain was driven by a notable acceleration in new orders and a sharp buildup in inventories, as firms moved to meet stronger demand and preempt potential supply disruptions. Inventories climbed to their highest level since 2010. While the pickup in activity itself is not particularly alarming, it did contribute to firmer input cost pressures, which could have implications for the inflation outlook.
• The report is consistent with the Beige Book’s characterization of overall activity as expanding at a slight to moderate pace, with manufacturing supported in part by strong demand tied to data centers and related infrastructure. While the Beige Book does not explicitly attribute this strength to policy, the pattern is consistent with the broader impact of tax incentives and elevated defense spending in underpinning activity.
• That said, there are clear areas of concern, particularly in the labor market and in sentiment. While the ADP report showed that the economy added 122,000 private sector jobs in May, surveys from both the Federal Reserve and the ISM suggest firms remain cautious about hiring. At the same time, inflation concerns continue to weigh on households and businesses, as budget constraints and margin pressures shape spending and investment decisions.
• While we remain constructive on the near-term economic outlook over the next three to six months, emerging signs of softness suggest the economy is increasingly vulnerable to a pullback. A prolonged conflict involving Iran could amplify these risks, particularly as households continue to face pressure from rising inflation and a decline in savings. At the same time, robust investment in AI-related infrastructure and technology remains a key source of support and is likely to partially offset broader moderation in consumption.

Iran Pushback: The conflict involving Iran is increasingly becoming a political liability for the White House. On Wednesday, a Republican-led House voted to restrict the president’s ability to initiate military strikes in Iran without congressional approval, marking a meaningful setback. This constraint is particularly significant given the administration’s reliance on targeted strikes to enforce its blockade in the Strait of Hormuz. In response, the White House appears to be pivoting back toward more nationalist policy positioning in an effort to rebuild political support.

• While the measure is unlikely to become law, it signals that support for the president may be beginning to erode. The Democrat-backed bill passed with the support of four Republicans, marking the first time such legislation has cleared the House after previous failures in both chambers. The vote is likely to prompt similar action in the Senate, which could further underscore growing political resistance to a conflict now entering its fourth month.
• The vote comes amid signs that the ceasefire is beginning to fray. On Wednesday, Iran launched a series of missiles targeting US airbases in Kuwait and Bahrain. While no American troops were killed, the strikes did result in at least one casualty. Although the president downplayed the incident publicly, reports suggest he may be willing to abandon the ceasefire if future attacks result in US fatalities.
• In an effort to regain momentum amid the conflict, the White House has revived nationalist rhetoric, including renewed references to territorial expansion. Secretary of State Marco Rubio noted that Greenland remains part of Denmark “for now,” echoing prior interest in acquiring the territory, while the US ambassador to Canada referred to the country as the “51^st state.” While largely symbolic, these moves highlight the administration’s attempt to rebuild political support.
• We think the longer the war continues, the greater the political toll on the president, particularly as the midterms approach. While this dynamic may increase pressure to reach a settlement, it is unlikely to compel the administration to accept an agreement that falls short of its core objective of preventing Iran from acquiring a nuclear weapon. Consequently, in our view, the risk of a prolonged conflict remains elevated.

Europe Talks: European allies are stepping up efforts to open negotiations with Putin aimed at ending the war in Ukraine. Germany, France, and the UK are expected to take the lead, seeking to ensure a meaningful role after earlier US-led talks stalled. Although Putin still appears to prefer engaging directly with Washington, he has not ruled out serious discussions with European counterparts. Taken together, these moves suggest that a diplomatic breakthrough in Ukraine may be closer than markets currently reflect.

AI Doubts? Tech shares fell after Broadcom issued a softer‑than‑expected AI revenue outlook. The company projected AI semiconductor revenue of about $16 billion for its fiscal third quarter, below consensus expectations of roughly $17.2 billion. The sharp sell‑off underscores how dependent the AI trade has become on chipmakers meeting or beating ambitious growth expectations to support elevated valuations, and may foreshadow further downside if earnings momentum starts to fade.

Credit Concerns: There are growing concerns that a default cycle may already be underway. PIMCO’s Chief Investment Officer has warned that the market could face higher losses than those to which investors have become accustomed. This comes as several financial firms caution that delinquencies may rise as leveraged buyout debt from 2021-2022 approaches maturity, even as credit spreads remain near historic lows. While systemic risks appear contained for now, the economy’s heavy reliance on credit leaves it vulnerable to a deterioration in liquidity.

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