Beyond the Fed: Where to focus now

Equity markets are trending higher as the week comes to a close.

The S&P 500 is up +1.5%, the NASDAQ 100 has gained +2.5%, and U.S. small caps (Solactive 2000) have risen +0.3% week-to-date. In Europe, the Stoxx 50 is outperforming the United States. It’s up +3.3% and on track for its best weekly finish in a month.

In commodities, gold has risen +2.6%, reaching all-time highs and heading for its best weekly streak of gains in five years.

In macro news, producer and consumer prices increased more than markets expected this week. That drove a temporary spike in yields, but heading into Friday, the 2-year (4.29%) is up just one basis point, and the 10-year (4.53%) is higher by three basis points.

The most important implication from the firmer-than-expected price data is that it likely means the Fed will be on hold through the first half of this year. With the Fed out of the picture, what will drive markets from here?

This week’s price data suggests that inflation picked up in the United States.

The headline CPI consumer measure, which includes food and energy, rose 0.5% month-over-month, exceeding the 0.3% consensus estimate. The core CPI measure, excluding food and energy, increased 0.4% month-over-month, also above the 0.3% expectation. Year-over-year, these figures reached 3.0% and 3.3%, respectively. Producer prices, which measure the price of input goods and services, also rose above consensus expectations.

What do the prints tell us?

The inflation data suggests that inflation is not making the same progress as it was six months ago. Importantly, we can gauge core PCE, the Fed’s favored inflation measure, with the data we have in hand. Since much of the price increases were in items outside those that feed into PCE, both reports suggest a 0.3% increase in core PCE prices.

While this is cooler than the 0.4% rise in CPI, it still probably means the Fed will keep rates steady for the next few meetings. The labor market is still solid and inflation progress is slowing. The Fed still views its current policy rate as restrictive (and so do we), which suggests policy rates are likely to move lower in the longer run. It will just be at a more gradual pace.

Investors have become accustomed to the Fed being a driving force in market moves. Over the last two years, the Fed’s decisions have matched market pricing leading up to each meeting. Now, the market anticipates the Fed to stay on hold until October, meaning the Fed is likely out of play for the next few months. So what will investors focus on?

Corporate earnings

This earnings season is well underway, with ~75% of companies having reported fourth-quarter figures. Reports indicate a strong earnings season. S&P 500 earnings growth looks like it will come in at 16.75% year-over-year in the fourth quarter, well above the 11.5% consensus at the start of the season. If this rate holds, it will be the highest reported growth since Q4 2021 and the sixth consecutive quarter of year-over-year earnings growth.

One of our preferred sectors, financials, is leading the way with the highest year-over-year earnings growth rate of all 11 sectors: ~52%. We believe M&A and capital markets activity will continue to thaw, acting as a tailwind for the sector.

While there is broad corporate enthusiasm for deregulation and a more business-friendly administration, tariff uncertainty is acting as a headwind.

According to FactSet’s natural language processing tool, 184 companies (about 50% of those reporting) have mentioned tariffs during earnings calls. As more companies report, we are likely to breach the 2018 trade war highs in the number of companies focused on tariffs.

Tariff risks

Yesterday, President Trump signed an action for his staff to develop a plan to impose reciprocal tariffs on U.S. trade partners.

The White House has already imposed 10% tariffs on Chinese goods and announced a 25% tax on all U.S. steel and aluminum imports, set to start next month. The latest action proposes new levies on a country-by-country basis to rebalance trade relations. Fresh import taxes would be customized for each country, meant to offset not just their levies on U.S. goods, but also non-tariff barriers such as subsidies, regulations, value-added taxes, exchange rates and other factors that limit U.S. trade. The reciprocal tariffs are expected to be imposed as soon as April.

What are reciprocal tariffs? In their simplest form, they levy the same tariff rate on a country that they levy on you. Doing this across 10,000 tariff lines only raises the U.S. weighted average tariff rate by 2%. However, adding non-tariff barriers (most importantly, value-added taxes) dramatically expands the definition of what might be “reciprocal.”

Generally, emerging market countries with smaller trading relationships charge high tariffs on U.S. goods. Canada and Mexico have 0% tariff rates with the United States, while China and the European Union have a 2% and 1% rate difference, respectively. Canada, Mexico, China and the EU make up more than 60% of U.S. imports. However, these numbers could rise dramatically if the administration follows through with including value-added taxes and other non-tariff barriers of trade. 

For what it’s worth, the equity markets seem to be relieved by the latest tariff news. The S&P 500 rallied materially yesterday toward all-time highs. The proposal to impose reciprocal tariffs is less onerous than campaign promises of flat universal tariffs, and the market also senses that the draconian starting point (including VAT taxes) and long lead time (White House staff will not be back with a recommendation before April) suggest this may be a catalyst to beginning negotiations with other countries. Indeed, the European equity market, which is more exposed to a trade war than the S&P 500, rose over 3% this week.

The strong European equity start

So far this year, European equities have gained +12.4% (Euro Stoxx 50), marking the best year-to-date performance since 1997. Europe, as an exporting economy, would likely face headwinds from tariffs, so why have European companies outperformed the United States so far? We attribute it to three factors:

1. Earnings expectations. Since summer 2024, earnings estimates for the Stoxx 50 declined over 6% due to a sluggish economic backdrop and consumer slowdown (domestically and in China). Those fears seemed to trough in late January, and since then, earnings expectations have increased nearly 1%. The earnings season in Europe had a strong start, with notable beats in technology, financials and luxury retailers.

2. The valuation gap. Over the last 10 years, European equities have traded at a 23% average discount relative to the United States. That discount started the year at 36%. Year-to-date, they have been buyers of that valuation gap, narrowing it by five percentage points to 31%.

3. Ceasefire talks. A potential ceasefire between Russia and Ukraine seems more likely. This week, President Trump and Russian President Putin reportedly agreed to start negotiating an end to the war in Ukraine. More information is expected during the Munich Conference, which continues this week, but for now, European markets are taking solace in the possibility of an end to the three-year conflict.

Market uncertainty has evolved. The Fed’s near-term path seems more certain, and corporate earnings reports continue to impress. Tariffs and geopolitical conflict still pose risks, but the developments from this week were positive on the margin. We believe asset portfolios should post solid, if unspectacular, performance in 2025. Investors should focus on sticking to their plans, and should consider building resilient portfolios by adding diversified sources of income and sources of less correlated returns. Your J.P. Morgan team is here to help.​