Policy Uncertainty and Declining Consumer Confidence Rattles Markets
Volatility has reentered the market lexicon as trade policy whiplash and the anxiety it’s creating around U.S. growth prospects has sent the S&P 500 and Nasdaq 7% and 10% off their respective highs. On Tuesday, the Trump administration imposed sweeping tariffs on Canada and Mexico, plus an additional hike on China. The new duties would have taken the average U.S. tariffs to rates not seen in decades. This caused unease to market participants as they tried to quantify how the rise in import costs will pass through to consumer prices. The new U.S. tariffs applied to roughly $1.5 trillion in annual imports, signaling to markets that the president is willing to inflict economic pain to generate new revenue and create domestic manufacturing jobs. The announcement pushed up expected inflation, with near-term CPI swap rates rising to the highest level since early 2023. Higher inflation will dampen real wage growth while limiting the Fed’s ability to cut rates.
The administration then walked back some of the tariffs, exempting automakers and Mexican goods and services that fall under the USMCA trade agreement for another month. This lack of consistency has exacerbated stock market moves as investors oscillate between growth optimism and policy-driven selloffs. In fact, the last three days have seen intraday moves in the S&P 500 of at least 1%, marking the first time we have had three sessions in a row since the inflationary year of 2022.
Tariff uncertainty has affected bond markets as well. Tuesday’s news caused the yield curve to bull steepen—short term yields falling faster than long-term—to reflect expectations of three rate cuts this year by the Federal reserve. This is a distinct departure from fewer than two that markets were pricing in just two weeks ago. Market participants view a trade tiff as reflationary in the short-term, but it also hampers global growth which is creating a bias for lower treasury yields and a further steepening of the curve.
The potential re-shaping of global alliances and trade is having an impact on global bond markets as well. German bunds have had a historic rout as debt markets have reacted to the nation’s historic plan to spend hundreds of billions of euros for defense and infrastructure investments. The retreat in German bunds reverberated through global debt markets, with Japan’s government bond yields reaching their highest level since 2009 and yields in Australia and New Zealand also rising.
The U.S. dollar index has continued its slump and suffered its largest two-day decline in over two years. It is now down to levels not seen since November following the U.S. election. The dollar trade was very crowded and likely has further room to unwind as front-end yields decline and the overall market backdrop looks more uneven. Despite the Federal Reserve keeping interest rates stable after a series of cuts in late 2024, inflationary pressures remain. If tariffs or funding freezes are to blame, however, the Fed may be less accommodative to cutting rates going forward as they will likely view these distortions as temporary or structural, not cyclical. The Fed will want to distance themselves from acting as a safety net for the administration’s objective of overhauling the economy.
The U.S. economy has shown a mix of resilience and emerging headwinds. Signs of slowing momentum have appeared with weaker data on retail sales, consumer confidence, economic surprise figures, and GDP tracking estimates. U.S. consumer confidence fell in February by the most since August of 2011 on concerns regarding the outlook for the broader economy. Stock market bullish sentiment is now down to levels on par with prior crises. The current economic cycle was extended and distorted thanks in large part to the most fiscal stimulus the United States has ever seen over a five-year period in history outside of WWII. Fiscal concerns loom large, with the federal deficit reaching $838 billion in the first four months of fiscal year 2025, and the national debt hitting a record $36.32 trillion.
Markets loathe uncertainty, and the current investment environment is rife with it. Risk assets will continue to be volatile across the board in this setting, and it is unlikely we reach a new equilibrium any time soon. In light of this, we continue to favor Agency MBS and equities with a low volatility/value tilt. Key risks remain to be sticky inflation, higher-for-longer rates, and policy uncertainty around the fiscal and trade agenda. Tomorrow’s employment report will present the next critical set of data to gauge whether recent weakness is just a soft patch or something more malignant.
Ryan Babeuf, CFA
Market Strategist
Ryan.Babeuf@EdgeWealth.com
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