Macro
The February Core PCE rose 0.37% month-over-month, pushing the annualized rate to 2.79%. The increase was driven by price pressures in goods and non-housing services, even as shelter inflation continued to moderate. Earlier in March, a softer CPI report raised hopes that inflation might ease without aggressive Fed tightening. However, those hopes were dented by the PCE release, which failed to confirm a consistent disinflation trend. Further compounding concerns, consumer inflation expectations surged to a 32-year high, and the ISM’s Prices Paid index jumped to 62.4 in March from 54.9 in January, signaling rising input costs for manufacturers. These data points reinforce the view that the U.S. economy has become more inflation-sensitive, with businesses now quicker to adjust prices, sometimes even preemptively.
The prevailing theme of uncertainty continues to weigh heavily on growth prospects. The lack of clarity surrounding U.S. trade policy, especially in the lead-up to the anticipated April 2 announcements, has paralyzed corporate decision-making. With trillions of dollars of trade potentially at stake, companies are reluctant to commit to long-term investments, amplifying the drag on growth. The most significant government-controlled expense item impacted by this environment is interest expense, particularly as much of the federal debt is now being refinanced at the shorter end of the curve, following long-end issuance under the prior Treasury Secretary. Prolonged uncertainty could delay corporate investment and hiring, increasing the risk of a slowdown or even recession.
The U.S. economy is undergoing a structural transformation under the current administration, necessitating a more flexible monetary policy framework. The Fed’s rigid 2% inflation target may prove increasingly unrealistic in a world undergoing geopolitical and economic realignment. While it’s politically challenging to adjust this target without achieving it first, a range-based inflation goal may become more appropriate. Expectations for a decline in services inflation have been frustrated by persistent stickiness, while new tariffs risk driving goods inflation higher. This uneven inflation profile may disproportionately impact lower-income households, particularly if tariff-driven price increases concentrate in essential goods.
Consumer sentiment is deteriorating. After four months of decline, confidence dropped further in March, nearing multi-year lows according to both the Conference Board and the University of Michigan surveys. Soft data like this often precedes a pullback in consumer spending, and therefore corporate earnings. Still, it’s worth noting that sentiment historically bottoms out just before actual conditions begin to improve. Economists are watching the U.S. consumer closely—the engine of growth over the past three years. Pandemic-era savings have now dried up, and household bank deposits as a share of disposable income have reverted to pre-pandemic levels. While this is partly due to a shift into high-yielding money market funds—now at record highs—over 80% of these assets are held by the wealthiest 20% of households, limiting the buffer for the broader population.
Labor market dynamics remain pivotal. The unemployment rate stands at 4.1%, near full employment, while job vacancy rates—having declined—recently rebounded to 4.6%. Historically, the U.S. has not entered a demand-driven recession unless the vacancy rate falls below the unemployment rate. The recent trend—where falling vacancies, not layoffs, absorb the impact of tighter policy—suggests a more resilient labor market than traditional Phillips Curve models imply. Still, policymakers caution that if vacancy rates fall below 4.5%, unemployment could rise more sharply, requiring greater caution from the Fed.
Conflicting objectives currently define U.S. economic policy. Tariffs are being deployed in multiple ways: (1) broadly, to address trade imbalances; (2) selectively, to protect strategic industries like steel and aluminum; and (3) country-specifically, to achieve non-economic outcomes such as curbing illicit drug trade. While hard economic data remain strong, soft data, centered on sentiment and expectations—are deteriorating, creating an unusual divergence. If labor markets hold up, this weakness in soft indicators may prove temporary.
The administration aims to reduce dependence on government spending, even as it grapples with a fiscal structure where most expenditures—Social Security, Medicare, defense, and interest payments—are politically or structurally difficult to cut. Despite rising interest burdens, the administration is reluctant to raise the retirement age or scale back Medicare. Discretionary spending, mainly defense, is unlikely to be trimmed given the current geopolitical environment and the defense innovation agenda.
A new and controversial plank of policy is the holding of Bitcoin as a reserve asset, sourced not from market purchases but from seizures and forfeitures. Only Bitcoin, not other cryptocurrencies, will be held, reflecting its status as the most established digital asset. The administration has chosen not to liquidate these holdings to avoid negative optics.
Markets are now eyeing the upcoming Fed meeting, which could be pivotal. Despite a 10% correction in equities and intensifying tariff-related uncertainty, the Fed has shown reluctance to cut rates. Without a compelling reason, the path to more than two rate cuts in 2025 appears difficult to justify.
The risk of a retaliatory tariff war is growing, increasing the likelihood of prolonged corporate investment paralysis—except in AI, which remains a rare capex bright spot. In a break from historical patterns, the dollar has not behaved as a haven. Instead, it’s depreciated against all G10 currencies in 2025, while gold has surged above $3,000/oz. This divergence suggests that global confidence in U.S. monetary leadership is being tested. Central banks are diversifying their reserves—reducing reliance on U.S. money markets and increasing allocations to foreign bonds, currencies, and gold.
The dollar remains indispensable, invoicing over 50% of global trade. Yet if these trends accelerate, and reserve managers increasingly seek alternatives, the world could face a new monetary order. While no substitute matches the dollar’s depth or liquidity today, persistent policy shocks and structural shifts could gradually erode its dominance.
Rates
Interest rates have come down significantly from their recent highs, though they remain above the levels reached during peak recession fears at the end of last year. Despite the decline, yields do not currently reflect expectations for aggressive Fed rate cuts. Elevated inflation and persistent risk premiums are keeping bond yields relatively high, at least for now.
That said, in a scenario where the economy weakens and unemployment rises sharply, the Federal Reserve is likely to respond swiftly with rate cuts. Such a move would likely lead to a bull steepening of the Treasury yield curve, where short-term rates fall faster than long-term ones.
Recent macro uncertainty and rising volatility in risk assets have driven investors back into fixed income, suggesting further downward pressure on yields. In March, a notable shift occurred as the correlation between equities and bonds turned negative—Treasuries rallied while stocks declined. Bonds are now positive year-to-date, whereas equities are down a few percentage points. This marks a return to a classic “risk-off” environment, where weaker economic data translates directly into market pessimism. This is confirmed by the Bloomberg Economic Surprise Index, which continues to trend lower.
The Federal Reserve, meanwhile, continues to avoid offering a strategic outlook on the broader economy. Scarred by its 2021 misstep, when it misjudged inflation as transitory and maintained excessively stimulative policy, the Fed has now adopted a more reactive, data-dependent stance. While this approach minimizes the risk of another policy error, it also adds to rate market volatility by removing a stable anchor for expectations.
Further complicating the outlook, recent fiscal and trade-related developments under the new administration have introduced additional macroeconomic uncertainty. There are growing concerns that the Fed could once again be slow to react, similar to its delayed response in late 2018. This risk adds another layer for investors to consider when pricing assets across the curve.
That said, the economy remains on relatively strong footing, giving the Fed some leeway to “wait and see” before making its next move. As long as the labor market holds up, the Fed can afford to be patient. However, they are also navigating an increasingly complex policy environment shaped by fiscal shocks and inflationary pressures.
Finally, it’s important to recognize that the neutral interest rate—the level that neither stimulates nor restrains the economy, has likely moved higher in the post-COVID world. Current policy rates are no longer significantly above that neutral rate. On Wednesday, the 10-year Treasury yield tested one-month highs at 4.365%, highlighting the market’s cautious optimism but also its sensitivity to evolving macro conditions.