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In the first quarter of 2025, the global economy experienced significant turbulence, primarily due to U.S. President Donald Trump’s implementation of extensive tariffs. These tariffs, announced as part of a “Liberation Day” initiative, targeted imports from numerous countries, aiming to reduce U.S. reliance on foreign goods. The broad scope of these measures sparked fears of a global trade war, leading to substantial declines in stock markets worldwide. Major indices, including the S&P 500 and Japan’s Nikkei, saw notable losses, while investors sought refuge in safer assets like gold, which reached record highs.
The economic uncertainty also led to downward revisions in growth forecasts. The OECD projected that escalating U.S. tariffs would slow global economic growth and increase inflationary pressures. Specific concerns were raised about the potential for these trade barriers to reduce global output and diminish household incomes, with possible retaliatory measures further exacerbating the situation. In the U.S. Federal Reserve Chair Jerome Powell announced a downward revision of U.S. GDP growth from 2.1% to 1.7%, signaling a slowdown in economic momentum. At the same time, the Fed raised its inflation forecast, reinforcing expectations of prolonged restrictive monetary policy to curb price pressures.
US equities faced headwinds in Q1, with the S&P 500 declining -4.3%, marking its worst quarterly performance since Q3 2022. The quarter began strongly, driven by large cap growth stocks holding near cycle highs until mid-February, the S&P 500 index hit a new record high as of February 19th. However, a sharp reversal occurred in the second half due to Policy uncertainty, Federal reserve caution, and Geopolitical risks.
A broad rotation from growth to value stocks occurred, with the equal weighted S&P 500 returning -0.61% outperforming the market weighted S&P 500 Index. This reflected investor shifts toward undervalued sectors and away from mega-cap stocks, which had dominated earlier gains. 7 out of 11 large cap GICS sectors ended Q1 positively, with Investors favoring defensive sectors like Energy, Healthcare and Consumer Staples which returned 10.2%, 6.5% and 5.2% respectively.
In fixed income markets, risk volatility created a compression along the Treasury curve, the 10-year yield fell from 4.58% to 4.20%, with roughly 40-basis-point tightening on any maturity over 2 years. The expectation entering the quarter was for under two federal fund rate cuts through the year as the market has increased the potential chance of second half economic slowdown due to tariff impacts. Now, this expectation has risen to three, resulting in an anticipated target range of 3.75% – 4.00% by the December meeting.
Inflation prints of 3.0% January and February 2.8% remain above the Fed target rate of 2%, which is why the yield curve remains inverted in the near term as market participants balance the short- term economic slowdown against the persistent inflation and the unknown impact of tariffs. Other central banks have started 2025 with 25-basis-point cuts, Canada, EU and UK as they follow the direction that the Fed set in 2024, but also need to balance the potential persistent inflation in the economy. Corporate spreads widened 20-basis-points from 4 year lows to 120 basis points at the 10-year, economic uncertainty filtering into the potential default rate on investment grade bonds.
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