Last week, the US stock market experienced significant fluctuations, driven primarily by concerns over tariffs which heavily influenced market sentiment at both the beginning and end of the weekMajor tech stocks faced notable declines, playing a crucial role in dragging down the overall market performance.

In the coming week, President Biden is expected to reveal more details regarding tariff decisions, which could potentially impact the market's expectations for Federal Reserve policy and consequently drive treasury yields and the US dollar higherThe resurgence of volatility in the markets appears imminent.

A Tough Test for the Federal Reserve

Among the most notable data from last week was the announcement of non-farm payrolls in January, which added just 143,000 jobs, slightly below market expectations, while the unemployment rate fell marginally by 0.1 percentage points to 4.0%. Analysts indicated that the employment market might have been influenced by recent wildfires in California and the cold weather affecting much of the country.

The consensus on Wall Street appears to be relatively positive about the state of the US labor market

Advertisements

The economy seems to be creating enough jobs to maintain a stable unemployment rateAlthough the pace of hiring has slowed since last year, most Americans who wish to find work are still able to do so, and layoffs remain relatively lowCompanies are biding their time, waiting for the President's economic agenda to materialize before finalizing any further hiring plansIndustry surveys reveal a general enthusiasm for tax cuts and deregulation, yet there is a cautious stance towards tariffs.

Notably, similar concerns have been reflected in consumer surveys as wellThe University of Michigan's consumer sentiment index plummeted from 71.1 in January to 67.8 in February, marking a significant decline for two consecutive monthsRespondents expressed rising inflation expectations, with a one-year forecast jumping from 3.3% in January to 4.3%, the highest level since November 2023. Five-year inflation expectations also saw an increase, from 3.2% to 3.3%, reaching its peak since 2008.

The economic uncertainty brought about by tariffs and the complex expectations surrounding inflation have led to mixed movements in the medium and long-term US treasury yieldsThe closely watched 2-year treasury yield rose by 4.2 basis points to 4.277%, reaching its highest level in two weeks, while the benchmark 10-year treasury yield fell by 8.2 basis points to 4.483%. Futures for the federal funds rate indicate that the first rate cut from the Federal Reserve may not occur until June.

According to a report by TD Securities, “Inflationary progress has stalled over the past few months, and uncertainty regarding how far the new administration will go on tariffs has increased, causing the Fed to be more cautious about interest rates, maintaining a steady policy rate until sometime this summer.”

Bob Schwartz, a senior economist at Oxford Economics, previously conveyed to reporters that the Fed has suggested a pause in interest rate hikes, as it wishes to assess the impact of rate changes on the labor market and inflation

Advertisements

However, some Fed officials have started incorporating tariffs into their forecasts, but the extent to which the President's executive orders might alter their assumptions regarding the timing, scale, or risk balance associated with tariffs remains uncertain.

Implications of Market Volatility

In response to the President's comments regarding tariffs, three major stock indices saw a sharp decline in the closing hours, completely erasing intra-week gains, leading the Nasdaq and S&P 500 indices to post back-to-back weekly declines.

Goldman Sachs noted that a significant way in which the stock market might come under pressure is through elevated tariffs impacting profit expectations and returns for the S&P 500. “If company management decides to absorb higher input costs, profit margins will be squeezedConversely, if companies pass on the higher costs to customers, sales volume may take a hit.” The firm estimates that each 5% increase in tariffs could reduce the S&P 500’s earnings per share by approximately 1-2%.

Market data indicated a mixed performance across sectors last weekConsumer discretionary and communication services posted the largest declines, with Tesla plunging 11% amidst the Federal Highway Administration announcing a suspension of approvals for all state electric vehicle infrastructure deployment plans for the fiscal year

Advertisements

Alphabet, Google's parent company, saw a drop of 9.2% in stock price, despite exceeding profit expectations for the fourth quarter, due to disappointing revenue performanceIn contrast, consumer staples, real estate, and energy sectors all gained 1%, with technology, financials, and utilities experiencing slight increases.

In terms of fund flows, US equity funds recorded their fourth consecutive week of outflows as investors grew increasingly wary of escalating geopolitical risks from trade tariffs and heightened concerns surrounding the earnings reports of key tech companiesAccording to data provided by the London Stock Exchange Group, net withdrawals from US equity funds reached $10.71 billion in the last week, the highest level since December of last year.

The disappointing cloud revenue growth reported by Alphabet, combined with AMD’s weak forecast for data center sales, has intensified investor concerns regarding substantial investments in artificial intelligence, resulting in a sell-off of $6.44 billion in large-cap stock fundsRisk aversion has also driven approximately $39.61 billion into safer money market funds.

Charles Schwab highlighted in their market outlook that the potential disruptions caused by tariffs and ensuing inflationary pressures have negatively affected market sentiment, pushing the volatility index (VIX) to breach the 20 mark at one pointThe rise in the one-year inflation expectations from the University of Michigan's consumer sentiment survey has also been cited as a reason for concern, with tariffs featured prominently.

Looking ahead to the upcoming week, other potential market-driving factors could include monthly inflation data

Advertisements

Advertisements