Stocks and bonds going in different directions Stocks and bonds going in different directions http://www.federatedinvestors.com/texPool/static/images/texpool/texpool-logo-amp.png http://www.federatedinvestors.com/texPool/daf\images\insights\video\sign-crossroads-small.jpg May 23 2025 May 23 2025

Stocks and bonds going in different directions

Equity and fixed-income investors are responding differently to tariff and fiscal policy uncertainty.
Published May 23 2025

Bottom Line

The ongoing uncertainty surrounding the Trump administration’s fluid tariff policies and Congress’ tax and spending legislation has served as a Rorschach test for investors. Looking at the same data, equity market optimists have sparked a 23% rally in the S&P 500 over the past six weeks, recovering all the ground lost in the post-Liberation Day waterfall decline. But bond pessimists have pushed yields on benchmark 10-year Treasury yields up from 3.9% to 4.6% over this same period. Something’s gotta give, and this wide divergence in investor sentiment will eventually narrow.

Tug of war between surveys and stats The hard economic data in the US continues to be solid, while the sentiment data remains dreadful. A few prominent examples:

  • Core CPI inflation held steady at a four-year low of 2.8% year-over-year (y/y) in April, while core PCE declined to a nine-month low of 2.6% in March.
  • Nominal retail sales during the two-month Easter and Passover season in March and April soared 5.2%, compared with gains of 3.0% y/y in 2024 and 1.9% y/y in 2023.
  • The labor market has been strong this year through April, despite layoffs of federal employees. Better-than-expected initial weekly jobless claims of 227,000 for the May nonfarm payrolls survey week suggest this favorable trend will continue. 
  • The NAHB Housing Market Index plunged from a nine-month high of 47 in January 2025 to a 19-month low of 34 in May.
  • The University of Michigan Consumer Sentiment Index plunged to a three-year low of 50.8 in May 2025, down from 52.2 in April and 74.0 last December. That’s the second lowest reading on record and the lowest since the all-time low of 50 in June 2022. Moreover, Michigan’s one-year inflation expectations are at a 44-year high of 7.3% in May 2025, up from 6.5% in April and 2.6% last November, due to tariff concerns.

Are we talking our book? What’s behind this divergence? It could be politics. The most recent Michigan survey suggests that its data skews significantly due to the political affiliation of its respondents. Consumer sentiment among self-described Democrats, which was a robust 91.3 in May 2024, plunged to a record low of 33.9 in May 2025. In contrast, the outlook of those who self-identified as Republicans rose from 53.0 in May 2024 to 84.2 now. For many people, the future looks brighter or darker depending on which party controls the legislative levers.

‘One big, beautiful bill’ Which brings us to the current partisan drama in Washington. The House narrowly passed an extension of Trump’s 2017 tax cuts that includes some additional economic stimulus. Failure to extend the previous tax cuts would have resulted in a $4.5 trillion tax increase in 2026, which likely would have pushed the economy into recession. But how do we pay for this continued largesse? The House has proposed a combination of tariff revenue; DOGE savings; expiration and repeal of green energy and EV credits; tighter eligibility for the Affordable Care Act, Medicaid and Supplemental Nutrition Assistance Program (SNAP) benefits; and stronger economic growth. Treasury Secretary Scott Bessent told Bloomberg today that addressing waste, fraud, abuse and inefficiency in the federal government could capture $1.5 trillion or more in budget savings over the next decade. The Senate gets its bite at the apple next week, and the ensuing compromise bill may be completed by July 4.

Now the fun begins In its current form, will this bill grow the economy and reduce the debt/deficit, or push the economy into recession and billow out the government’s balance sheet? To a significant degree, that’s a function of whether you use dynamic scoring or static analysis to analyze it. There’s no shortage of opinion, which is helping to fuel the sharp differences between stock market strength and bond market weakness.

How will the Fed respond? Will the hard or soft data prove to be the accurate harbinger, and how will the Federal Reserve respond over the balance of 2025 considering it has adopted a wait-and-see monetary policy approach? Critics concede that the economy is fine now but predict it will deteriorate rapidly in this year’s second half. Those more constructive believe that, once the global tariff negotiations are complete and the tax & spending bill is law, economic growth will accelerate and the debt/deficit stabilize.

The Fed is unlikely to complete its policy framework review (which it conducts every five years), before its annual symposium at Jackson Hole, Wyo. in August. Given policymaker’s desire to see more data on inflation, unemployment and economic growth, the consensus view is that the Fed is unlikely to cut interest rates more than twice this year, with the first quarter-point cut possible at the September 17 FOMC meeting. 

Adjusting our forecasts The liquidity, equity and fixed-income investment professionals who comprise Federated Hermes’s macroeconomic policy committee met last Wednesday to discuss President Trump’s ongoing tariff negotiations and proposed tax legislation, and their potential impact on economic growth and inflation, the Fed’s monetary policy plans and financial market performance. 

The Commerce Dept. flashed a GDP decline of 0.3% in the first quarter of 2025, compared with a final gain of 2.4% in last year’s fourth quarter. But the core private domestic final sales component rose a solid 3.0% in the first quarter versus 2.9% in the fourth. The overall print was negative due to a record 41% surge in imports in the first quarter due to tariff-related fears. That subtracted 5 percentage points from GDP growth. 

  • We raised our estimate for second quarter 2025 GDP growth from 1.3% to 1.9%, as we expect a much smaller sequential increase in imports, while the Blue-Chip consensus reduced its from 1.7% to 1.1% (within a very wide range of -1.0% to 3.0%). The Atlanta Fed’s GDPNow estimate is a gain of 2.4%. 
  • We left our forecast for third quarter 2025 GDP growth unchanged at 1.7%, while the Blue-Chip gutted its from 1.7% to 0.2% (within a range of -1.8% to 1.7%).
  • We raised our estimate for fourth quarter 2025 growth from 2.0% to 2.1%, while the Blue-Chip consensus cut its from 1.8% to 0.7% (within a range of -1.1% to 2.2%).
  • Consequently, we trimmed our full-year 2025 growth projection from 1.8% to 1.6%, while the Blue-Chip consensus also lowered its from 2.0% to 1.2% (within a range of 0.6% to 1.7%).
  • Given the prospect of lower negotiated tariffs globally and stimulative tax cuts this year, we remain constructive on the longer-term economic impact of these initiatives. As a result, we raised our forecast for full-year 2026 growth from 2.5% to 2.7%, while the Blue Chip reduced its from 1.9% to 1.3% (within a range of 0.5% to 2.0%).
  • Given the near-term risk of higher inflation due to the tariffs, we raised our year-end 2025 forecast for core CPI inflation growth from 2.9% to 3.0% (compared with actual core inflation of 2.8% in April 2025), while the Blue Chip raised its from 2.9% to 3.2% (within a range of 2.8% to 3.7%). We also raised our year-end 2025 estimate for the core PCE inflation rate from 2.6% to 2.7% (compared with actual core inflation of 2.6% in March 2025), while the Blue-Chip consensus raised its from 2.6% to 3.0% (within a range of 2.6% to 3.5%).
  • We left our year-end 2026 estimate for core CPI inflation unchanged at 2.6%, while the Blue Chip raised its from 2.7% to 3.0% (within a wide range of 2.2% to 3.4%). We also left our year-end 2026 estimate unchanged for core PCE inflation at 2.3%, while the Blue Chip raised its from 2.5% to 2.9% (within a range of 2.3% to 3.7%).

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Tags Markets/Economy . Equity . Fixed Income . Liquidity .
DISCLOSURES

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

Gross Domestic Product (GDP) is a broad measure of the economy that measures the retail value of goods and services produced in a country.

Consumer Price Index (CPI): A measure of inflation at the retail level.

The National Association of Home Builders/Wells Fargo Housing Opportunity Index reflects the percentage of households with median incomes that could afford new homes at median prices.

Personal Consumption Expenditures Price Index (PCE): A measure of inflation at the consumer level.

S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designated to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.

The University of Michigan Consumer Sentiment Index is a measure of consumer confidence based on a monthly telephone survey by the University of Michigan that gathers information on consumer expectations regarding the overall economy.

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