Macro
Although inflation has started to cool, consumers’ long-term inflation expectations have risen to a 30-year high. This unexpected increase is driven by heightened inflation concerns and rising prices for specific goods that significantly affect consumers. Surprisingly, despite elevated inflation expectations, yields at the long end of the yield curve have moved lower, reflecting market caution.
Consumer fears about inflation are intensifying, signaling that the U.S. economy is still far from achieving robust momentum. Economic data released this week presented a mixed outlook. February’s flash Manufacturing PMI exceeded expectations, suggesting pockets of resilience, while initial unemployment claims slightly surpassed forecasts, partly driven by increased filings in Washington, D.C., following federal layoffs. Regional indicators also portrayed caution; the Philadelphia Fed reported subdued activity, while January existing home sales disappointed expectations amid concerns about high interest rates, affordability, and declining demand. Additionally, labor market indicators reflected uncertainty, particularly following federal layoffs concentrated in the Washington DC area. The housing market faced ongoing pressure, highlighted by a decline in existing home sales and a five-month low in homebuilder sentiment due to rising rates and affordability issues.
The January FOMC meeting minutes aligned mainly with market expectations, noting that officials anticipate the balance sheet runoff concluding around mid-2025. Fed speakers reiterated a cautious, data-dependent approach, underscoring lingering uncertainty regarding inflationary effects from ongoing fiscal and trade policy debates. The likelihood of a rate cut in March remains minimal (around 2%), but markets expect the first cut by July, with modest reductions totaling around 40 basis points projected through 2025.
President Trump has continued an aggressive expansion of executive power, significantly influenced by his collaboration with Elon Musk and the Department of Government Efficiency (DoGE). Trump has issued approximately 75 executive orders targeting reducing or dismantling federal agencies, including USAID, FHA, FAA, FEMA, USDA, EPA, and CFPB. Additionally, an audit of the Federal Reserve aims to increase presidential oversight of financial regulators, and Musk’s team has indicated further scrutiny of the Department of Defense.
Internationally, Trump is actively pursuing tariffs, notably implementing an additional 10% tariff on Chinese imports, impending 25% tariffs on steel and aluminum effective March 12, and potential reciprocal tariffs targeting major trading partners. Furthermore, 25% tariffs on automobiles, silicon chips, and pharmaceuticals are expected by April 2. These actions, though controversial, risk intensifying inflation pressures and contradict Trump’s pledge to reduce living costs.
Domestically, Trump endorses a Republican-led proposal for $4.5 billion in tax cuts, currently under debate in Congress. This proposal, coupled with planned cuts to Medicaid and increased budgetary constraints, risks creating tensions between Trump’s social welfare-dependent working-class supporters and his pro-business backers, notably Elon Musk and Commerce Secretary Lutnick.
Internationally, Trump and Putin seem close to securing a cease-fire in Ukraine. The deal may be favorable if Ukraine obtains adequate security guarantees. However, Trump refuses to offer these assurances, demanding that Europe handle the situation. Additionally, Trump insists that Ukraine compensate the U.S. for over $150 billion in military aid through $500 billion worth of mineral exploitation rights. This stance has severely strained U.S.-Ukraine relations, especially Trump’s relationship with Ukraine, while highlighting the unreliability of unconditional U.S. military support.
Trump continues to pressure European nations to significantly increase defense spending from the current average below 3% of GDP, urging a 3-4% target. Although this push could substantially benefit European defense companies, it raises serious questions about regional stability, security, and fiscal feasibility moving forward.
Rates
It has been a quiet week in the rates market. Treasury yields have slightly decreased, with the two-year yield falling from 4.27% to 4.25% and the benchmark 10-year yield dipping from 4.48% to 4.46%; the 20-year yield was down from 4.90% to 4.83%, and the 30-year yield remained unchanged. We also saw a drop in yields across Europe and the rest of the world. Japan was the only outlier, where 20Y yields increased from 1.98% to 2.03%. The Treasury auctions included a $16 billion 20-year sale yielding 4.83% and a $9 billion 30-year TIPS sale yielding 2.403%, marking the highest yield since 2001. The US dollar index was largely unchanged, although a strengthening yen attracted attention. Gold rose by 2.1%, achieving a new record high, while Bitcoin futures fell by 2.8%, and WTI crude edged down by 0.2%.
Earlier this year, market consensus lacked bond optimism, with most analysts expecting the 10-year yield to rise above 5%, reflecting strong growth and renewed inflation concerns. However, Investor Snippets had suggested that the market’s growth outlook for the US economy might be overly optimistic, and normalization in shelter costs would further ease inflation pressures. Despite yields stabilizing around 4.5%, there remains a notable downside risk.
Currently, the 10-year yield is closely linked to US growth expectations. Without significant shifts in growth or inflation trajectories, yields are expected to hover near 4.5%. However, economic shocks or declining consumer confidence could dampen consumption, negatively impacting growth forecasts and subsequently pushing yields lower. Additionally, emerging uncertainties, particularly related to tariffs, could influence business sentiment, though many businesses have become somewhat desensitized to tariff-related rhetoric.
The term premium on the 10-year Treasury hit its cyclical peak in January and is currently around the 2023 peak level, coinciding with a recent re-inversion of the yield curve toward the end of last year.
Further upward pressure on yields continues to stem from discussions around the federal budget and debt ceiling. Recent Federal Reserve minutes highlighted that officials are contemplating pausing or slowing quantitative tightening (QT) amid the ongoing debt-ceiling debate, leading to modest declines in Treasury yields and a steeper yield curve. Concerns around potential bank reserve volatility, possibly masked by increased liquidity, underscore risks associated with continuing QT in the face of legislative uncertainty. An earlier-than-anticipated pause in QT could slightly benefit the market by reducing the pace of Treasury issuance. Nevertheless, many strategists still foresee QT extending into late 2025.
Credit
Amid growing geopolitical tensions, rising tariffs, and mounting pressures on economic growth, the current tightness in credit spreads appears overly optimistic. Weakening consumer confidence and stalled momentum in manufacturing signal that merely exercising caution may no longer sustain U.S. GDP growth above trend levels.
This economic environment will likely exert downward pressure on corporate margins and reduce interest coverage ratios. As a result, the current narrow spreads across credit grades seem excessively optimistic. The primary remaining appeal in fixed income markets is the relatively high all-in yields, which remain attractive compared to the norms in the recent history of 15 years post-GFC.
Investors should be particularly cautious regarding sectors vulnerable to immigration policies, tariff escalations, and broader economic and regulatory shifts. Although consumer confidence remains relatively healthy for now, it continues to trend downward, raising concerns about future sustainability as pandemic-era savings are gradually depleted.
Equitiies
In a shortened trading week due to Presidents’ Day, U.S. equity markets weakened compared to last week’s mixed performance. Indexes closed lower this week as declines on Thursday and Friday erased earlier record-setting performances, with the S&P 500 achieving fresh record closes on Tuesday (ATH 6,129.58) and Wednesday (ATH 6,144.15) before retreating. The equal‐weighted version managed to outperform its cap‐weighted counterpart by roughly 100 basis points following two consecutive weeks of underperformance, while the tech-heavy Nasdaq lagged due to sizable losses in marquee technology names, including META (-7.2%), AMZN (-5.3%), and TSLA (-5.1%). Top-performing sectors included Utilities (+1.39%), Healthcare (+1.07%), Energy (+1.06%), Consumer Staples (+0.94%), and Real Estate (+0.44%). Sectors lagging behind were Consumer Discretionary (-4.30%), Communication Services (-3.68%), Industrials (-2.06%), Materials (-2.01%), Financials (-2.00%), and Technology (-1.82%).
Amid this environment, the broader market narrative saw a rotation from cyclicals and technology into more defensive sectors. However, the semiconductor sector emerged as a relative bright spot despite the overall market retreat, with the semiconductor index (SOX) only falling about 0.5%. This resilience was supported by an optimistic AI growth outlook, evidenced by BABA surging over 15%, strong analog semiconductor updates with ADI up 11.3%, and comments from former President Trump that lifted companies such as TXN (up 10.3%) and INTC (up 5.3%). Political uncertainty and trade tensions added to market volatility, with ongoing debates in Washington over the budget—where the House and Senate remained at odds—and looming risks of a government shutdown around mid-March. At the same time, tariff discussions intensified as Trump warned of possible 25% tariffs on autos, semiconductors, and pharmaceutical imports as early as April, even as the administration floated alternative ideas like using tariff revenues to replace taxes, and the EU expressed openness to tariff cuts to avoid a trade war.
Adding to the bearish sentiment were cautious earnings insights from retailers like Walmart, heightened geopolitical risks, and broader concerns over economic growth, as reflected in weaker PMI readings and softening housing data. Analysts also pointed to extended positions in momentum and speculative retail stocks, noting that if the selloff deepened, CTAs could offload as much as $61 billion in US stocks, compared to only $10 billion in purchases during a rising market. Yet, there were supportive signals as well, notably from the Treasury, where indications that the Federal Reserve might slow or pause its balance sheet runoff later in the year, combined with a negative turn in the Citi Economic Surprise Index, suggested a possible shift toward a more dovish policy stance. Even as some retail sales figures—like those from Walmart and the restaurant sector—appeared weak, they were partly attributed to weather conditions against a backdrop of generally robust consumer sentiment.