KBRA Financial Intelligence

3 Things in Credit: Middle East Tension, Powell vs. the LEI, and United Airlines

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Welcome, market participants, to another 3 Things in Credit. I’m Van Hesser, Chief Strategist at KBRA. Each week we bring you 3 Things impacting credit markets that we think you should know about.

In this age of uncertainty, one point of speculation is just how much of higher costs—think tariffs—would be passed along to customers. A Richmond Fed survey found that 67% of businesses planned to increase prices by at least the amount of the cost increase. Just over half planned to pass along the cost increase in full, while 14% planned to increase prices more than the cost increase. This should come as no surprise. After the past few years of wealth creation—be it via consumer-received stimulus and wage growth or corporate high margins—there is an overarching sense of “Oh, they can afford it.” We get a sense that’s changing.

This week, our 3 Things are:

1. Middle East tension. We’ll think through how important oil volatility is.

2. Powell vs. the LEI. We’ll explore two divergent views of the economy.

3. United Airlines. We’ll revisit the company’s unconventional earnings guidance from April.

Alright, let’s dig a bit deeper.

Middle East tension.

Economically speaking, we often remind investors that geopolitical events, in and of themselves, generally don’t move markets. What does move markets is when those events alter supply/demand relationships in an economically material way. The price of oil is usually the bellwether in this regard.

Most recently, we saw the price of oil and other commodities spike in the case of the Russia-Ukraine war. In that case, the price of oil remained elevated for roughly 2.5 years, jumping from around $75 a barrel to an average of around $93 a barrel over that time frame, from year-end 2021 to mid-year 2023. Now, obviously there are all sorts of factors affecting the price of oil beyond concerns over war-constrained supply. For instance, over that time frame we had the highest inflation in 40 years. And the price of oil eventually retreated to a more normal trading range, despite the war continuing. But clearly concern over supply limitations weighed on the price of oil during that time. That concern is the issue is a function of visibility or lack thereof. With 20/20 hindsight, yes, the price of oil retreated, presumably because of rising growth concerns related to monetary tightening imposed in the face of heightened inflation. But at the time, war and its effects seemed the bigger threat.

In this go-around, it is noteworthy that, thus far, there has been no attack on refineries and no blockage of the Strait of Hormuz, through which nearly a quarter of the world’s supply flows. Throw in a possible ceasefire and redoubled commitment to diplomacy, and the global economy, for now, appears to have avoided that possible shock.

Should something crop up to put Middle East supply at risk, the important consideration from a growth standpoint, from a credit standpoint, is less the magnitude of the shock and more the duration of that shock. A spike in oil would be unwelcome, of course, to creditors, as it feeds the stagflation beast. Today, markets are breathing a sigh of relief.

Alright, on to our second Thing—Powell vs. the LEI.

We talked a couple of weeks ago about the fact that we’re in a data vacuum at the moment, in the sense that there are big shoes to drop over the course of the second half, namely the actual impact of tariffs and the outcome of the Big Beautiful Bill. It has been surprising to us that risk investors, stock and credit, have bid assets aggressively to aggressive valuations when the market consensus is that those two unknowns (and they are largely unknown at this point) will likely be stagflationary. Not in a severe way, the degree to which Jamie Dimon warns, but stagflationary nonetheless. Imperfection in markets priced for perfection.

Which brings us to two updated views from credible sources on the economy this week that really are quite different. The first comes from none other than Fed Chair Powell, who testified this week in front of Congress that the U.S. economy is “strong” and “solid.” I have to admit, that’s a bit of a head scratcher, with housing struggling, retail sales slumping, and industrial production sagging. Yes, unemployment remains low, but consumer and commercial sentiment has turned down in high-profile surveys and the Fed’s own Beige Book. Some of this is normalization post-stimulus. Much of this reflects the uncertainty over trade and immigration policies. Chair Powell might be using the “strong” and “solid” labels because he just doesn’t feel comfortable cutting interest rates amid that inflation uncertainty. In fact, my guess is that’s the case.

We would contrast that view with that of the Leading Economic Index compiled by the Conference Board. Its latest reading, out this week, came in at its lowest level in 10 years. The LEI’s fall marks 35 consecutive months of negative year-over-year readings. It bears mentioning that every negative reading in the index since 1975 has coincided with a recession in the U.S. Over the past six months, which has deteriorated much more than the previous six months, only two of the index’s 10 components were positive: the yield curve and manufacturing average weekly hours. In the negative column were the following: the credit index, the S&P 500 stock index, consumer expectations, ISM new orders, building permits, manufacturers’ new orders for consumer goods and materials, and initial claims. Manufacturers’ new orders for capital goods was unchanged. The result in May triggered the index’s “recession signal,” which, interestingly, the Conference Board was quick to point out that it is not forecasting. The recession signal means the decline in the index of that magnitude historically has preceded recessions. OK, then. Call it what you will, but I wouldn’t call the economy “strong.”

Alright, on to our third Thing—United Airlines.

We thought it would be interesting to check in on United Airlines. Recall that back in April, at the height of market anxiety and uncertainty, United gave a most unusual earnings guidance: two scenarios, “Stable” and “Recessionary.” Under Stable, the company forecast full-year 2025 EPS of $11.50 to $13.50, a year-over-year increase of 8% to 27%, while under its Recessionary environment scenario, it expects EPS of $7-$9, a fall of 15% to 34%—in other words, a range of plus 27% to minus 34%. That’s quite a gap. At the time, management cautioned, “The outlook is dependent on the macro environment, which the company believes is impossible to predict this year with any degree of confidence.”

So here we sit, a couple of months later, and a world apart from April 15 in terms of market evolution and consumer and business confidence, which are so important to this bellwether consumer discretionary name.

The consensus 2025 estimate today is $10.15, which would be a 4% decrease year-over-year. So, the estimate is splitting the difference. Since April 15, the day it issued its guidance, United stock is up 18%, outperforming the equal-weighted S&P 500 by nearly 8 points.

Pulling back, we have a consumer discretionary name—coming off its best Q1 performance in five years—that is, in the eyes of the analysts that cover the name, due for a modest pullback in earnings. That squares up with the broader narrative that is taking root—one where the policy initiatives of the new administration have created enough uncertainty to form a headwind to earnings growth, even though, in the case of United Airlines, core customers are firmly ensconced in the advantaged part of our Two Economies, wealthier households and larger businesses. That suggests slowdown more broadly.

So, there you have it, 3 Things in Credit.

1. Middle East tension. Prospects of a shock have diminished.

2. Powell vs. the LEI. Evidence of slowdown is mounting, which doesn’t square up with the Fed chair’s assessment.

3. United Airlines. Analysts are forecasting a modest year-over-year earnings downdraft, one that’s a far cry from the company’s bear case outlined in April.

As always, thanks for joining. Next week we will be out of the office on holiday. We’ll see you in a couple of weeks.