A Relative Calm

The U.S. Treasury market continues to show sensitivity to the daily news flow, and, with the news on trade skewing generally constructive, interest rates have fallen. Higher longer-term Treasury yields have been reflecting all sorts of risks — most acutely, policy uncertainty — so progress on trade policy is a positive.

However, there was another dose of uncertainty injected into the bond market recently. President Trump’s public criticism of Fed Chair Jerome Powell escalated, with some observers concluding that the president would oust the Fed chair based on his unhappiness with the pace of interest rate cuts.

The fears of such an outcome, expressed not only in rising bond yields but also in volatile equity markets, have centered around the independence of the Federal Reserve. If the Fed chair were forced to act at the whim of whoever was in the White House under the threat of dismissal, monetary policy would become a political tool: That, by definition, would drive short-term decision making that may run counter to the longer-term mandate of the Fed, which is to support both long-term price stability and full employment. For investors, the outcome of a politicized Fed would likely be higher longer-term interest rates. This would be required to compensate bond buyers for the risk that monetary policy would become too easy, allowing inflation and inflation expectations to become unanchored. However,  President Trump toned down his criticism earlier this week and stated, “I have no intention of firing him," and the markets heaved a sigh of relief.

The U.S. equity market enjoyed three straight days of strong gains, with the tech-heavy NASDAQ posting gains of over 2% each day. It appears to be a classic relief rally, with the year-to-date underperformers leading the way. Low volatility and value underperformed, while momentum stocks found their footing after some significant sell-offs.

Overall market volatility remains elevated, but has certainly displayed a renewed sense of relative calm after the post-Liberation Day gyrations. Will it last?  Unfortunately, we don’t know the answer. For a hint, it is always useful to point back to the source of investor angst, which has been policy volatility.

China is increasingly standing alone while other U.S. trading partners are sitting at the negotiating table. We caution investors against reading too much into the headlines, but to say that the situation is tense is likely an understatement. Most recently, the Trump administration has attempted to take down the temperature by suggesting that the 145% tariffs on Chinese goods could be substantially reduced, and President Trump expressed optimism about securing a ”very good” deal with China. However, Treasury Secretary Bessent acknowledged that formal talks had not yet begun. Chinese officials have taken an aggressive stance in the meantime, stating that no negotiations have taken place and dismissing any news of progress as groundless. China insists that the U.S. must cancel all unilateral tariffs as a show of good faith before formal negotiations can begin. In the meantime, Chinese authorities have warned their trading partners against striking deals with the U.S. that are unfavorable to China. 

The real economic impact of this trade impasse has yet to be felt, although we are starting to see signs of what may come: Shipments to the U.S. from Chinese ports have slowed, with many being outright cancelled due to the trade war. This could lead to supply issues and even empty shelves in several months after retailers deplete their inventories. Major U.S. retailers have warned President Trump of potential supply shortages and the unsustainability of the trade war. While many companies did front-load purchases ahead of the tariff announcements, it is clear that the inflationary risks from supply constraints are rising.

Trade news continues to dominate the headlines, though investors have had the opportunity this week to focus on corporate fundamentals. With just over 30% of S&P 500 companies having reported, the picture is relatively mixed. There was strong earnings growth driven by specific sectors, but there were challenges with revenue surprises and concerns about consumer spending. Financials, technology and consumer discretionary stocks are leading with sales and earnings “beats” of Wall Street analyst forecasts. Technology was particularly strong with over 17% earnings per share growth.

We are particularly interested in the comments related to the U.S. consumer, as signs of stress are emerging among lower-income households. This stress is expected to grow as the tariff-related price increases would tend to hit these households the hardest. Analysts seem to be holding steady on expectations for 2025 earnings, although we anticipate forecasts will start to soften as the impacts of the trade war become more quantifiable. The S&P 500 continues to sell at the elevated valuation of 19.5 times forward earnings against a longer term average of 17, and this valuation vulnerability is potentially exacerbated by fragility in earnings estimates as we move forward through the year.