Market Update

Dear Friends & Clients,

We hope you’re doing well and enjoying spring. There is obviously a lot to unpack from a market perspective over the last couple of months. Below is our best attempt to provide a high level overview of recent developments, but please do not hesitate to reach out with any questions—that’s what we’re here for.

“If you give me a lever and a place to stand, I can move the world.” -Archimedes

There are two main levers that influence the trajectory of the global economy: fiscal policy from lawmakers and monetary policy from central banks. Currently, in the US, both are tight and proving to be headwinds for markets. While Powell recently emphasized that the Fed would step in if the labor market began to falter, they do have a dual mandate after all, the policy rate of 4.25% versus an inflation rate consistently coming in under 3% is a bit tight^4,5. On the fiscal side of things, last fall, investors were hoping that the Trump administration would begin with tax cuts and deregulation and sort out the thornier trade issues later. This was a reasonable assumption, as that was the blueprint for the last Trump administration when 2017 was all about passing the Tax Cuts and Jobs Act. A good part of March’s volatility can explained by the fact that investors got the opposite. This sequencing is important as starting with renegotiating trade while the Fed is running tight policy amplifies the pressure on the economy.

Although treasury secretary Bessent has alluded to escalating the trade fight in order to later deescalate on more favorable terms, the timing is unclear, and thus the uncertainty for investors, persists⁹. Also, the announced tariffs were much higher than the market anticipated as the tariffs were calculated in order to close trade imbalances with each nation rather than matching the outright tariffs imposed on US goods and services⁷. While there will undoubtedly be much debate over the definition of “reciprocal” in the weeks to come, the main takeaway is that the uncertainty around trade is increasing rather than decreasing. Consequently, we think the onus is on the Fed to return to neutral policy to shore up the labor market, and minimize recessionary risks, while we wait on trade negotiations to come to a conclusion.

We are currently in an extremely “noisy” environment for investors and consequently recommend viewing developments through the lens of “how does this impact fiscal or monetary policy” to determine the net economic effect. An economy on solid footing can withstand either restrictive monetary policy or restrictive fiscal policy, but not both.

It’s a target rich economic environment, but below are more details on what we think are the highlights:

• Slowdown: The Fed has been purposefully keeping rates elevated to slow the economy to bring inflation down closer to their 2% target. Because of this, economic data has been softening for the last 6 months. However, now, investors are worried that this controlled slowdown is going to accelerate into a recession due to unpredictable trade policy denting business confidence and potentially raising consumer prices. With unemployment still extremely low (around 4%), there are a lot of dots to connect before recession becomes a “likely” scenario.
• Consumer Sentiment: Much has been made of the recent cratering consumer sentiment numbers, but this has proven to not be a very good predictor of consumer spending behavior, which is what we really care about when it comes to corporate earnings¹. Employment and wage data has recently had better predictive power for consumer spending, and so far, unemployment remains very low, and while wage increases have slowed, wages over the last year have more or less kept pace with moderating inflation². In very recent data (last full quarter), we have begun to see wages lag inflation by a wider margin as employers tighten their belts in anticipation of potentially higher input costs. The erosion of purchasing power is something we’ll be watching closely.
• Inflation Rebound?: Whether or not tariffs would spark as much inflation as some fear remains an open question, as consumers have to be able to pay the higher prices for inflation to take root. If not enough consumers can afford the higher prices, prices will come down to meet them at the expense of corporate profitability. One of the reasons inflation took off so quickly in the wake of COVID was due to the massive amount of stimulus, which created a flush consumer who was able, and willing, to pay the higher prices. Consumers do not have the same capacity now to bear higher prices as savings are back to pre-pandemic levels³. This means that corporations potentially face the dilemma of decreased sales, or decreased profitability, as a clean transfer of higher prices to the consumer doesn’t look feasible.
• Trade Theory: A fundamental pillar of economics is that trade allows for specialization, which prevents the exchange of goods from being a zero-sum game. Instead, the parties involved can develop increasing expertise in their niche, boosting the overall output, as well as the quality, for all trade participants. Of course practice is always messier than theory, and some protectionism and targeted tariffs have always been a staple of government policy. Afterall, even if countries are close allies they don’t want to be 100% dependent on each other for critical technologies or materials. When it comes to national security or “critical industries” every country has some trade barriers. However, what you can get a rare economic consensus on is that tariffs should remain targeted, as their widespread use can come with myriad unintended consequences and dent the specialization (cost reduction) benefits of trade. It is true that the majority of the world has higher net tariffs on the US than the US has on them⁶. If treasury secretary Bessent’s analysis that we are raising tariffs to hopefully wind up with lower terminal global tariff rates after negotiations proves to be correct, this would present an “upside” risk for markets. Only time will tell.
• Back to the Future: watching futures markets trade during the rollout of the tariff plan yesterday afternoon was quite a rollercoaster. Investors had largely anticipated only reciprocating existing tariffs, which would have still increased the aggregate tariff rates substantially (likely 7.5 - 12.5% higher). Instead, the plan that was laid out now has the average effective US tariff rate at 22.5%, which is the highest since 1909⁸. While secretary Bessent reportedly told lawmakers that these tariffs are meant to be a “ceiling, not a floor,” the impacts will be substantial if they remain in place for an extended period of time. Bessent’s alma mater (Yale) has published some numbers on the anticipated impacts (link #8 in the footnotes). Most importantly, while there will be many emphatic opinions on how this will play out, the global economy has changed tremendously since we’ve last seen tariffs at these levels and it’s consequently difficult to try to draw meaningful parallels with what happened nearly 100 years ago. Regardless of the outcome, markets will be hoping for a fast conclusion to this period of extreme uncertainty as the net effect is very tight fiscal policy.