February 2025 Market Commentary

February 24, 2025

• Donald Trump inaugurated as 47th President.
• Fed leaves rates unchanged at January meeting.
• Fourth quarter GDP grew at 2.3% rate.
• Returns: S&P 500 2.7%. Bloomberg US Aggregate Bond Index 0.5%..

Donald Trump was sworn in as President on January 20th and moved quickly to implement a number of his proposed policies. Through February 3, Trump had signed 50 executive orders, the most by a President in his first 100 days in more than 40 years. His initial salvo of executive actions focused on immigration, energy, government reform, and trade.

Of particular interest, and perhaps concern, for economists and investors alike have been Trump’s plans to impose tariffs, as they are effectively a tax on consumers who must pay more for imported goods. The concern, depending on the degree to which tariffs are implemented, is that they could put upward pressure on inflation, depress consumer spending, and impact broader economic growth. At the end of January, Trump announced he was placing tariffs on the United States’ three largest trading partners, Mexico, Canada, and China, which in 2024 accounted for ~$2.2T in total trade. According to the nonpartisan Tax Foundation, the tariffs would shrink economic output by 0.4% and increase taxes by $1.1T between 2025 and 2034, amounting to an average tax increase of more than $800 per US household in 2025.

However, prior to the tariffs taking effect, Trump suspended them for 30 days after the two countries agreed to make certain concessions. Tariffs on Chinese imports, however, took effect at the start of February. The degree to which Trump’s tariffs and threats thereof are meant to be negotiating tactics or long-term policy remains to be seen. Also unclear is which other countries Trump might threaten with tariffs, though it is widely expected he will announce plans to levy tariffs on European imports at some point.

Economic growth slowed at the end of the year with 4Q24 GDP expanding at an annualized rate of 2.3%, down from third quarter’s 3.1% pace. For the full year, GDP expanded 2.8%, just 0.1% slower than in 2023. Despite the softer fourth quarter growth, some underlying details remained encouraging, particularly consumer spending, which accelerated from 3.1% in the third quarter to 4.2% in the fourth, marking the fastest pace of growth since 1Q23. Partially offsetting the strong consumer spending was a 5.6% decline in business spending, the sharpest drop since 1Q23, perhaps reflecting uncertainty on the part of businesses both before and after the election. Overall, the data indicated that the economy entered 2025 with good momentum.

Employment ended 2024 on an upswing as nonfarm payrolls added 256K jobs in December, the strongest pace of growth since March, easily surpassing the consensus forecast of 164K. Unemployment declined 0.1% to 4.1% leaving it range bound between 4.1% and 4.2%, where it has been since June. The labor force participation rate remained unchanged at 62.5%, while average hourly wages increased 3.9% from a year ago. The report corroborated remarks by Fed Chair Jay Powell following the Fed’s December meeting that the slowdown in labor market conditions is happening in a “gradual and orderly way” as opposed to a way that “really raises concerns.” Other employment data released in January showed job openings increased ~250k in November to 8.1M, the first reading above 8M since May, suggesting that the demand for workers remains healthy. The improved data suggests the Fed does not need to consider additional cuts for now to support what appeared, in late summer and early fall, to be a faltering jobs market.

Headline consumer inflation (CPI) rose 0.4% in December, in line with expectations and at its fastest pace since March 2024. Forty percent of the increase was driven by energy prices which rose 2.6% in December. Compared to a year ago, CPI rose 2.9%, the fastest annual pace since July. Despite the increases, markets seemed relieved that the monthly and annual increases were in line with expectations, and not any higher. Core readings, excluding food and energy prices, were also encouraging, rising 0.2% and 3.2% for the month and year, respectively. Both measures came in 0.1% less than expected. Another positive development was a further slowing in shelter prices, which increased 4.6%, compared to a year ago, the slowest pace since Jan. 2022. Commenting on the data, Fed Governor Christopher Waller said that “As long as the data comes in good on inflation or continues on that path, then I can certainly see rate cuts happening sooner than maybe the markets are pricing in.”

While Waller may ultimately be correct, the Federal Reserve left rates unchanged at its January meeting following 100 basis points (1.0%) of cumulative rate cuts at its three prior meetings. Speaking at his post-meeting press conference, Fed Chair Jay Powell said that following the recent rate cuts, and with the economy remaining strong, the Fed does not need to “be in a hurry” making further adjustments to monetary policy. Regarding the types of conditions that would warrant further rate cuts, Powell said “we’re going to be focusing on seeing real progress on inflation or alternatively, some weakness in the labor market before we consider making adjustments.” When questioned about how President Trump’s proposed policies might impact inflation and the broader economy, Powell said the Fed would take a wait-and-see approach to see how the policies were articulated before it could even make “a plausible assessment” of their potential impact. To the extent Trump’s proposed policies place upward pressure on inflation, it would likely delay the timing of the Fed’s next rate cut. At month end, markets were expecting approximately two additional Fed rate cuts in 2025.

Market returns for the month were positive across the board, with large caps (S&P 500) gaining 2.7% while small caps (Russell 2000) rose 2.6%. International markets also enjoyed positive returns led by developed markets (MSCI EAFE) which jumped 5.2%, while emerging markets (MSCI EM) gained 1.7%.

Fixed income markets also enjoyed positive returns in January, with the Bloomberg US Aggregate Bond Index, the broadest measure of the US bond market, up 0.5%, aided by a small decline in interest rates. However, that belied intramonth volatility in which the 10-year Treasury yield reached its highest level since October 2023. Yields initially rose in the first part of the month in response to positive economic activity including manufacturing and employment data. The favorable data reduced market odds of further Fed action on rate cuts, leading to assumptions that yields would remain higher for longer. In turn, the 10-Year Treasury yield briefly surpassed 4.80%, triggering talk of it potentially breaching 5.0%, a level not seen on a regular basis since 2007.

Market sentiment quickly underwent an about-face following the mid-month release of December consumer inflation (CPI) data. Core CPI, excluding food and energy prices, came in below expectations and at its lowest level in about six months, leading to a furious bond market rally. The combination of weaker inflation and still-strong employment- an ideal situation for the Fed-resulted in the market entertaining the idea of additional Fed rate cuts, helping push yields lower. Fed Governor Waller’s comments discussed above helped further reduce yields. The rally extended further in the last week of the month, triggered by a flight-to-safety trade, with money moving out of equities and into Treasury bonds. The scare was due to the release of a new Chinese AI model that raised questions about the high valuations attributed to America’s tech giants, i.e. “Mag 7”. The rush into Treasuries resulted in yields ending the month almost exactly where they started.

Municipal bonds experienced a similar progression to Treasuries, with yields rising during the first half of the month before falling through the remainder. Rising yields to start the month drew buyer interest that carried over through the rest of the month. That momentum led yields to close the month at lows last seen in mid-December. The 2-year AAA muni yield fell eleven basis points (0.11%), while the 10-year AAA yield fell seven basis points (0.07%), faring slightly better than the Treasury market over the period.

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