After a slow start to the month, equity markets rallied over the last 10 days to reach new all-time highs in the S&P 500. With that, investors have witnessed a stunning turnaround from the volatility and fear that characterized the April market lows.
What’s the difference between April and today? Trade negotiations. Nearly all the volatility in April was attributed to trade policy, so it makes sense that the market recovery is directly tied to the somewhat positive developments in negotiations with China and the EU, despite recent setbacks with Canada. The coming week will be closely watched by market participants, as the July deadline for the “pause” in global tariffs looms large over the global economy.
In the background, the Fed continues to monitor both inflation and the labor market closely. The most recent press conference indicated that two rate cuts are still anticipated, although many analysts believe only one is likely. Any rate cut would provide a short-term boost to equity markets, but the underlying reason for a cut is a growing concern over an economic slowdown. The negative Q1 GDP report can be partially explained as an anomaly, driven by the rapid acceleration of inventory purchases by U.S. companies trying to get ahead of tariffs, but that may not be the full story. Many critical economic indicators continue to soften at a pace suggesting the Fed may need to intervene sooner rather than later.
Part of the economic concern stems from a steep inversion in the yield curve between the 3-month and 2-year Treasury rates. The yield on the U.S. 2-Year Treasury note stands at approximately 3.76% and the U.S. 3-Month Treasury Bill yield stands at approximately 4.30%. This signals that credit markets are not functioning normally, creating a barrier for banks to provide the capital needed by companies and consumers. While the spread between the 3-month and 10-year is essentially flat, any further decline in mid-term rates could trigger another inversion point. For bond investors, this month has delivered a modest return, but it has come at the cost of increased stress on the banking system.
Overall, we remain cautiously optimistic that economic data will begin to improve as Q2 comes to a close. If it does, the current market rally could have the momentum to continue through the rest of the year. If not, the next six months in the market may depend heavily on the Fed’s willingness to stimulate growth.