Macro
The Federal Reserve has kept interest rates steady against a backdrop of an increasingly uncertain economic outlook. While this decision was expected, it also provided relief to markets that the Fed did not rush to conclusions. Markets responded positively to the Fed’s stance, reaffirming the view that tariff-related inflation is likely transitory—reassuring that further aggressive tightening is not imminent. The market has shifted from inflation concerns to rising recession risks, which have become more pronounced in recent months.
The tone of the March FOMC meeting was largely seen as dovish, even though Chair Jerome Powell’s prepared remarks were rated highly neutral by sentiment scoring models. Bloomberg Intelligence’s natural language processing model gave his speech a near-zero score, reflecting a balance between hawkish and dovish language. Still, markets responded positively, interpreting Powell’s focus on labour market dynamics and his framing of tariff-driven inflation as “transitory” as supportive signals.
Despite this, some investors remain concerned that the Fed might once again underestimate the persistence of inflation by dismissing current pressures as temporary. However, this has yet to show up as a bear-flattening yield curve, which would be expected if these concerns became more widespread.
Over this period, investor sentiment has evolved—from initial optimism over tax cuts and deregulation to growing concern about tariffs and consumer health. As a result, investors have moved toward the long end of the yield curve, pushing the 10-year Treasury yield down by 65 basis points from its peak.
Recent economic growth has largely been fueled by aggregate consumption. So far, consumer weakness has been concentrated in lower-income groups and has not meaningfully impacted overall growth. However, consumer confidence indices have weakened, with rising caution evident in softer retail data. Retail sales increased just 0.2% last month, below expectations, while housing affordability pressures are intensifying, reflected in three consecutive monthly declines in existing home sales.
Labour market softness is most visible in the government sector, where austerity measures proposed by the Department of Government Efficiency (DOGE) are shrinking the workforce. Initial jobless claims have increased, indicating early signs of broader vulnerabilities in the labour market. If this trend spills into the broader economy, it could trigger a slowdown that demands a policy response from the Fed.
There is growing consensus that the U.S. government needs restructuring to improve efficiency. Since World War II, federal revenues have averaged about 17% of GDP, while spending has averaged 19%. However, from 2019 to 2024, revenues remained around 17%, while expenditures ballooned to 27% of GDP. Maintaining a 6–7% fiscal deficit during a period of full employment is widely seen as fiscally irresponsible.
As fiscal tightening proceeds, short-term economic pain is likely, but the broader goal is to stabilize the economy through a “3-3-3” framework: 3% growth, 3% inflation, and a 3% federal deficit by 2028.
The February inflation report, due on March 28, is a key economic release next week. Core PCE inflation is projected to rise by 0.35%, up from 0.28% previously—almost double the rate consistent with the Fed’s 2% annual target. This increase is likely driven by price pressures in goods, health care, and financial services, which have offset declines in other areas. Headline PCE inflation is expected to remain stable at 0.3%.
Consumer spending likely rebounded by 0.6% in February after falling 0.2% in January, supported by demand for essential healthcare goods and early purchases ahead of anticipated tariffs. Personal income is estimated to have risen by 0.5%, down from 0.9% in January, supported by wage growth and government transfer payments. The personal savings rate is expected to tick down to 4.5% from 4.6%.
Given firm inflation and resilient spending, the Fed’s decision to hold rates steady and revise inflation forecasts higher appears justified. If upcoming labour data comes in weaker than expected, the 10-year yield could move back toward 4%.
The Fed has acknowledged that recent data looks softer, though it maintains that there’s no immediate cause for alarm. The central concern is mounting uncertainty for businesses, which has not yet been fully reflected in hard data. Nonetheless, the macro outlook has become more negative and opaque, with both consumer and business sentiment deteriorating. A notable indicator of weakening demand was the sharp decline in the Philadelphia Fed’s index of expected new orders, marking its largest two-month drop since 1968. Meanwhile, bank balances have declined to pre-pandemic levels, wage growth has slowed significantly over the past year, and inflation-adjusted debt levels have risen across all income brackets. Freddie Mac data shows that the serious delinquency rate for multifamily housing has risen to 42 basis points – the highest level since the post-global financial crisis period.
The new administration, supported by leadership in the wirehouse, is attempting to “detox” the economy by potentially front-loading economic adjustments, even though this approach may place short-term pressure on markets. Treasury Secretary Scott Bessent recently emphasized this stance, remarking that while a recession isn’t necessarily imminent, there’s no guarantee it won’t occur, adding that “corrections are healthy,” signalling readiness to tolerate short-term volatility for longer-term economic stability.
The political cost of a recession is significant, yet historical trends indicate that downturns early in a presidential term tend to be less politically damaging. Since World War II, recessions occurring within the first two years of a presidency resulted in the incumbent party retaining the White House in six out of seven cases. Conversely, recessions in the final year of a term consistently led to electoral defeats, notably Eisenhower, Carter, Bush Jr., and Trump 1.0. Notably, these downturns have rarely influenced control of the Senate or House.
Currently serving his second term and mindful of conserving political capital, Trump faces strategic choices regarding his economic agenda. He remains the only Republican president since the 1980s to have secured the popular vote under typical economic conditions—Bush Jr.’s popular vote win occurred amid the extraordinary circumstances following 9/11. Given this backdrop, Trump may need to reassess his focus on tariffs, especially as recent polls indicate globalization and trade rank low among voters’ priority concerns.
Rates
The U.S. Treasury curve is poised to steepen after the March FOMC meeting, which the market interpreted as broadly dovish. Investors responded by slightly increasing the odds of three rate cuts by year-end, pricing in around 83 basis points of easing, with some options markets assigning a 20% probability of rates falling below 2.5%. However, caution remains warranted. The Fed emphasized the “uncertain” nature of the economic and inflation outlook, and this isn’t new—over the past two years, markets have repeatedly priced in rate cuts to 2.5% or 4% only to reverse course. Another round of excessive rate-cut expectations may similarly fail to materialize.
Following the Fed meeting, the yield curve steepened as investors gained confidence the central bank would respond quickly to any economic weakness. Chair Powell’s remarks were perceived as leaning toward growth support, particularly as he downplayed recent inflation expectations and used the term “transitory” in reference to tariff effects. While the BI natural-language model found his tone balanced—neither clearly hawkish nor dovish—his comments on labour market resilience and temporary inflation drivers supported risk assets.
The market is currently pricing the neutral rate at 3.5%, while the Federal Reserve estimates it closer to 3%. At the same time, growth forecasts are being revised downward. These are still forecasts, but if hard economic data begins to weaken meaningfully, the long end of the yield curve could adjust significantly lower.
Ongoing uncertainties, such as tariffs and fiscal austerity programs like DODGE, are impacting consumer and business sentiment, which could lead to decreased consumption. If this situation starts to affect the labour market and unemployment begins to rise, the Federal Reserve is likely to respond promptly with interest rate cuts.
While nominal interest rates and inflation remain elevated, the key question is the pace and path of potential Fed cuts. For now, the Fed remains in a “wait-and-see” mode, but if unemployment were to rise sharply, a 50 bps cut – similar to the September 2024 move – is entirely plausible.
With bond-equity correlations turning negative again, Treasury yields have served as a partial hedge during periods of risk-off sentiment. Yields have rallied when equities sold off. For rates to sell off meaningfully from here, markets would need to price in a much greater risk of recession.
The 5Y/30Y curve has now been at its steepest level since September, sitting at 59.4 bps, whereas the closely watched 2Y/10Y curve has steepened less significantly and stands at 30.2 bps. This divergence reflects market concerns that the Fed may be reluctant to cut rates aggressively, as inflation risks are still seen as credible. The 2Y, which has already priced in many of the expected cuts, has been less responsive than the 5Y.
The front end of the curve reflects growth asymmetry—the risk of economic slowdown prompting a more accommodative Fed. The long end, however, is more influenced by supply dynamics. With increased issuance expected from Europe, global investors may find higher yields abroad, putting upward pressure on long-term U.S. yields.
Meanwhile, the U.S. Treasury is expected to continue issuing substantial debt to finance the deficit, with Scott Bessent largely maintaining the issuance strategy set by his predecessor, Janet Yellen. Yellen concentrated on issuing short-term debt during her tenure, even as long-term rates hovered near historic lows. This approach was pursued despite persistently high deficits, but it missed a critical opportunity to lock in low-cost, long-term financing. As a result, a significant portion of U.S. debt now matures in the near term, increasing vulnerability to higher refinancing costs as rates rise.
With monetary policy now restrictive and interest rates elevated, Treasury Secretary Bessent faces a much more difficult environment. Rolling over the maturing debt has become considerably more expensive, and issuing longer-term bonds would mean locking in today’s high rates—further straining public finances. Consequently, Bessent is leaning toward continued issuance at the front end of the curve, where yields, while elevated, remain lower than longer-dated alternatives. This limited flexibility underscores the lasting impact of missed opportunities during previous rate cycles.
Credit
During 2020–2021, the corporate credit market experienced a significant wave of refinancing activity, driven by ultra-low interest rates. The average maturity of that debt was typically between five and seven years. As a result, a substantial maturity wall is now approaching over the next 12 to 24 months. This debt will need to be refinanced at much higher rates, increasing the interest burden on US corporations.
Adding to the challenge, macroeconomic uncertainty is beginning to creep into the credit markets. Credit spreads are likely to widen as uncertainty grows, further amplifying refinancing costs. In short, the combination of higher interest rates and widening spreads will lead to increased financial pressure on corporate borrowers.
Currently, spreads across all forms of fixed income remain extremely tight. The problem with this is the lack of adequate risk premiums—credit instruments are trading as though they carry minimal risk, effectively behaving like Treasuries. This leaves almost no cushion for credit risk, making the market more fragile in the face of economic shocks.
Although spreads have widened slightly in recent weeks, they still price in less than a 5% probability of recession. This assessment appears to severely underestimate the current macroeconomic risks.
Despite the cloudy macroeconomic outlook, corporate balance sheets remain relatively robust, and demand for credit is expected to hold steady. However, this resilience is not universal. Segments of the market composed of lower-quality issuers are already being aggressively repriced and remain most vulnerable to further deterioration in economic conditions.
A more significant widening of spreads is likely to occur only after hard data confirms a deterioration in the U.S. consumer. Consumer weakness tends to unfold with high velocity and non-linear patterns, making it difficult to anticipate and respond to in real time. Once it begins, rates can spike too quickly for markets to adjust.
Going forward, corporate commentary on the health of their consumers—and the consumer behaviour trends they are observing on the ground—will be crucial in understanding where risks may materialize first.
Equities
The S&P 500’s 10% fall in just 16 trading days challenges the uptrend established since the bottom in October 2022. Although this decline represents a typical annual 10% peak-to-trough drawdown, most trend indicators remain positive, albeit nearing a negative inflexion point. Despite some recovery, the index continues trading below key technical thresholds—including its 50-, 100-, and 200-day moving averages – signalling the bull market remains unconfirmed. Importantly, all major U.S. indexes are above their golden cross (50 DMA above 200 DMA); however, the proximity between the 50 DMA and 200 DMA is the closest since December 2023. Year-to-date, defensive sectors have outperformed, with Energy (+7.31%), Healthcare (+6.18%), and Utilities (+3.24%) leading returns
The buying power at current levels is noteworthy; for instance, Wednesday, March 20, marked one of the strongest recent trading sessions, with the S&P 500, NASDAQ, and Russell 2000 rising by 1.08%, 1.41%, and 1.56%, respectively. Market breadth also showed significant improvement, with 367 stocks closing higher. Nevertheless, underlying risks persist, including the vulnerability of U.S. tech to retaliatory tariffs and growing concerns about the sustainability and cost intensity of AI infrastructure investments.
Technology stocks, particularly the Magnificent Seven, have significantly dragged index returns this year, declining 12% year-to-date and wiping out approximately $2 trillion in market capitalization. In contrast, the remaining 493 stocks have collectively risen 1%. Despite largely relinquishing the gains fueled by the AI-driven rally from late 2022, fiscal 2025 earnings growth forecasts for the Magnificent Seven remain robust at 21.7%, significantly outpacing the 9% projected growth for the rest of the market. This divergence, coupled with eased valuations, continues drawing investor interest.
However, broader earnings expectations across U.S. equities have been revised downward from 9% to 7%, reflecting softer economic data and increased uncertainty. Since early 2023, the magnitude of positive revenue surprises has declined, raising questions about the sustainability of revenue growth. Further rotation back into tech might require improved earnings visibility. Given Friday’s triple witching event, short-term volatility could also spike, with $4.5 trillion in options expiring.
AI has introduced structural opportunities and challenges. While supporting long-term innovation, AI threatens traditional SaaS businesses as companies increasingly develop tailored, in-house software solutions. Moreover, supporting AI infrastructure is highly capital-intensive. Capex-to-EBITDA ratios for hyperscalers surged from ~17% to 26.7%, driving Capex-to-sales and Capex-to-free cash flow ratios to the highest levels since 2000. This increased capital intensity could constrain dividends and debt repayments, shifting long-term value toward next-generation application-layer companies rather than infrastructure incumbents.
Small-cap stocks, measured by the Russell 2000, have notably underperformed. Despite a brief rally in March, small caps remain down over 6% in the past six months and flat over the last year, although up roughly 20% from their 2022–2023 lows. Several factors have hindered the anticipated breakout, including the Fed’s delayed rate cuts, macroeconomic uncertainty heightened by geopolitical tensions and supply-chain disruptions, and disappointing earnings—over 27% of Russell 2000 constituents reported negative earnings in 2023.
Over the last two decades, the Russell 2000 has gradually lost its performance edge versus the S&P 500, primarily due to its lack of exposure to dominant mega-cap technology names like the Magnificent Seven, which constitute nearly a third of the S&P 500. This has widened the performance gap, turning small-cap investment from a reliable outperformer into a tactical timing play sensitive to macro conditions. Moreover, the Russell 2000’s heavier weighting towards cyclical sectors such as Industrials, Financials, Materials, Energy, Real Estate, and Utilities positions it as a barometer of Main Street rather than the global technology disruptors represented in the S&P 500. Consequently, the correlation between small and large caps has decreased significantly from over 90% pre-GFC to around 70% today.
Historically, strong two-year equity rallies have often preceded heightened volatility, such as the 50% gains observed during 1998–1999 and matched again during 2023–2024. In the late 1990s, market gains were broad-based, whereas recent strength has been narrowly concentrated in mega-cap tech. Excluding the Magnificent Seven, annual returns have averaged only about 9–10% in the past two years, with the broader market nearly flat year-to-date without them, underscoring growing concentration risk.
The historical pattern suggests markets often bottom before crises are fully resolved. For example, during the Cuban Missile Crisis in 1962, markets bottomed seven days into the 12-day standoff, recovering significantly before the crisis concluded. This tendency may offer perspective amid current geopolitical and policy uncertainties.
Growth expectations continue to be downgraded and priced into equities, creating an environment of increased volatility. CEOs face a complex landscape of trade tensions, regulatory uncertainties, and escalating geopolitical risks. Investors await the April 2 tariff developments, potentially impacting market sentiment further.
The NFIB Small Business Survey recently signalled a notable improvement in small business expansion outlooks from the lows of 2024. Conversely, homebuilding stocks—a traditional leading indicator – have underperformed since September 2024, potentially foreshadowing weakening consumer trends. Falling homebuying activity typically precedes reduced consumption, further signalling caution for broader economic recovery.