Central banks are treading carefully

The 2018 trade conflict between the US and China has felt like an apt analogy to the current environment. By late 2018, business sentiment deteriorated,¹ recession concerns rose, and the S&P 500 Index sold off by nearly 20% in a short period.² By the time investors had become increasingly bearish,³ the policy mix was changing. The Trump administration announced a 90-day tariff pause with China and the US Federal Reserve became increasingly more dovish. The following year was strong for risk assets.⁴

As the saying goes, history often rhymes. Over the weekend Treasury Secretary Bessent met with Chinese trade officials in Switzerland, and the result appears to be a significant de-escalation of tariffs — down to 30% from 145% for 90 days. Understandably, markets are taking this very positively. While tariffs are higher than last year, it’s a significant step down by the US administration from the worst-case scenario.

Here’s what else happened last week.

1. Fed: Remains in wait-and-see mode

The Fed remains stuck between a rock and a hard place. Uncertainty around tariffs has resulted in both upside risks to prices and downside risks to employment. Our sense is that the next move in rates should be lower, but until the labor market shows greater signs of weakness, we expect the Fed will hold rates where they are. Unemployment claims and payroll data have held up well in recent months. The push-pull between encouraging but backward-looking economic data and current sentiment data means the Fed is likely to remain in wait-and-see mode.

2. BOE: Gradually and carefully cutting

The Bank of England (BOE) cut its policy rate by 25 basis points last week as was widely expected, though the vote split was closer than anticipated with two members voting for no change.⁵ Survey data have pointed to sticky inflationary pressures in the UK,⁶ but we expect lower oil prices, a stronger currency, and US tariffs will mean fewer inflationary pressures in the coming months. The UK labor market, while not collapsing, is showing signs of slack.⁷ Rate cuts are gradually feeding through into lower mortgage rates, which could give the UK consumer more confidence to increase spending later this year. If that happens, we expect domestically focused small-cap UK stocks to potentially benefit.

3. Earnings season: Strong quarter, but guidance hard to give

First quarter earnings season is well underway with more than 75% of S&P 500 Index companies having already reported. Earnings results have largely surprised to the upside in line with the normal rate.⁸ Forward guidance from US companies, however, reflects heightened uncertainty. Many businesses have so far refrained from issuing negative earnings per share guidance, and mentions of recession during earnings calls have climbed sharply since last quarter. Mentions of layoffs, however, haven’t moved materially higher. 

4. Tech: The usual suspects

A look under the hood reveals that the US technology and communication services sectors have led the stock market’s rally in recent weeks.⁹ This marks a reversal from the first three months of the year, when poor performance in those sectors held the broader market back. Continued weakness outside of tech and communication services means that if the performance of those sectors were to slow again, the stock market’s recent rally could begin to stall.

5. Conflict in Kashmir isn’t meaningful for markets

Tensions between India and Pakistan are rising after the two countries engaged in their worst confrontations in decades. While there’s potential for further escalation, investors should remember that historically the impact of regional geopolitical conflicts on broad markets has tended to be muted. The Pakistan stock markets have sold off heavily,¹⁰ but we don’t expect these tensions to have a meaningful impact on broader financial markets.