Investors Seek Foreign Ports During US Trade Storm
What happened last week?
Last week, the S&P 500 inched up by 0.28% while the Dow and Nasdaq declined by -1.14% and -0.62%.
Investors continued to grapple with the effects of the administration’s tariffs and US-China tensions. The US Federal Reserve maintained rates in a 4.25%-4.50% band citing that the tariffs could lift inflation for a short period of time.
Meanwhile, the European Central Bank (ECB) lowered rates 25bps to 2.25%. President Trump remarked the Fed was “too late” in cutting rates.
3 Things to Know
Despite some initial positive headlines around tariff negotiations with Japan, tariff risks — particularly sectoral — are increasing
Sectoral tariff reviews for pharma/semis and reciprocal tariff negotiations are only now getting underway. Many of the countries facing high tariffs don’t have the resources of Japan or the EU to commit to buying more US energy or goods.
Moreover, while ostensibly remaining open to talks, for now the Trump Administration appears to be trying to isolate China, publicly stating that reciprocal tariff rates negotiated with other nations might be influenced by those countries’ willingness to curb their own trade flows with China.
Monetary Policy Is Not Coming to the Rescue
Chairman Powell noted that it is “too soon to say” when asked for the Fed’s assessment of the impact of trade policy. Critically, there is no real precedent for the current proposed tariff regime.
We view the current swelling of inflation expectations alongside low unemployment and jobless claims as signals that the Fed does not yet need to ease.
We further believe they will want to see hard data showing employment slowing and or inflation falling before cutting rates.
With markets pricing roughly 3 ½ rate cuts in the balance of 2025, it is likely that if inflation picks up, and employment doesn’t fall, a market reevaluation of the Fed’s policy steps may occur at some point ahead.
Fixed Income Recovers
The Fed remains in “wait and see” mode and is in no rush to cut rates. Powell also noted that while current levels of federal debt “is not at an unsustainable level”, it’s “better to address the debt situation sooner rather than later” as the path of federal debt growth is unsustainable.
These comments appeared to be a comment on market concerns over the current US budget negotiations and possibly higher future deficits. S&P rating agency echoed this view on Monday, when it said in a report: “The outcome of the US government's budget process and policy negotiations over the coming months will help determine policies that inform our view of US sovereign creditworthiness.”
Given the Fed’s reticence to cut rates near-term, longer-term Treasury rates are unlikely in our view to drop much further given uncertainty over future inflation, the possibility of an increasing US budget deficit, and potentially declining future foreign demand for longer maturities.
Comments this week by President Trump about his dissatisfaction with Chairman Powell and the Fed’s unwillingness to lower rates will be closely monitored by the market.
Should this situation escalate beyond words towards an active effort to remove the Fed Chair prior to his term expiry in May of 2026, bond investors would likely be even less inclined to own longer-dated Treasuries for fear that the any new Fed chair might steer towards overly stimulating growth by cutting rates too deeply.
See our weekly CIO Strategy Bulletin for more details