What We Are Watching for in June

• Tariff updates. The 90-day pause on reciprocal tariffs that was announced in April is scheduled to expire in early July. Meanwhile, the US is negotiating with various countries while new tariff announcements have continued apace. Market action over the past two months reveals that when tariffs are expected to be low and/or certain, markets respond positively
• Equity market breadth. S&P 500 breadth has notably improved in the past two months; currently, just over half of constituents are above their 200-day moving averages. A broader market is a healthier market, so if more stocks continue to demonstrate strength, it bodes well for future equity index performance. Breadth seen so far in 2025, where the “other 493” in the S&P 500 have outpaced the Magnificent Seven, is a good sign
• International equities. Will international equities continue to outperform domestic equities? Even after their sharp rebound in May, US equities have lagged international equities on a year-to-date basis. Which of these two opposing forces will prove more important: the inexpensive international equity valuations, or the persistent growth differential that favors the US economy and equity market?
• New nonfarm payrolls created in May will be reported on June 6. Current estimates for May nonfarm payrolls created are 125,000 jobs, a deceleration from a strong 177,000 new jobs created in April. The strong labor market has been the most important pillar underpinning our optimism on the US economy for the last several years. A weakening labor market would cause us to be significantly more cautious on risk assets
• Will inflation continue to fall toward the Fed’s 2% target? CPI for May 2025 will be reported on June 11, about a week before the June 17-18 Federal Reserve Open Market Committee Meeting. In addition to any change to the Federal Funds rate (we expect no change), the committee will release its quarterly Summary of Economic Projections (SEP). In the March SEP, FOMC members raised their inflation forecast and lowered their growth forecast. Will these trends continue, auguring a slower economy? Currently, the market is expecting the Fed to hold interest rates steady, although it is pricing in one 0.25% cut in about September 2025 with a second 0.25% cut in December 2025. Only two months ago, in April, the market had expected the Fed to cut the rate by a full percentage point by year end

Notable May Observations

• Inflation eased. The Consumer Price Index (CPI) – published on May 13 – reported inflation of 2.3% year-over-year, a deceleration from the prior reading of 2.4% and well below highs seen in recent years. It does, however, remain above the Fed’s 2% target, which is why we continue to expect interest rates higher for longer
• Equities rebounded sharply after April tariff volatility, with the S&P 500 Index handily outpacing its international developed market counterpart, the MSCI EAFE Index. The S&P 500 gained 6.3% in the month, while the EAFE Index added just 4.7%. This brings year-to-date performance for the S&P 500 back into positive territory, at 1.1%, though this is still notably lower than EAFE’s 17.3%
• Interest rates rose. Most tenors across the yield curve rose by 20-25 basis points (0.20% to 0.25%) as inflation remained above 2% and various Fed officials delivered hawkish commentary, on top of the Moody’s downgrade of US Treasuries
• The Fed held the Federal Fund Rates steady at its May 7 meeting, while noting that uncertainty remains elevated
• Jobs were unexpectedly strong in April, at 177,000 compared to estimates of 138,000
• The US consumer is still spending money. Retailers reported decent same-store sales growth and decent earnings growth for the first quarter of 2025
• Trump’s tariffs were blocked by the US Court of International Trade on May 28, which ruled that he had exceeded his executive authority under the International Emergency Economic Powers Act (IEEPA). A federal appeals court granted a temporary stay the next day

After a volatile equity market in April, it was the bond market’s turn to be volatile in May. After yielding 4.0% in early April, the 10-year Treasury note yield rose as high as 4.6% in mid-May, before falling back to 4.4% by the end of the month. Why were bond markets volatile, and what does that mean for investing?

We believe that US bond markets were volatile due to a confluence of events, some of which may prove temporary while others are likely to be longer-lasting. The events were varied, including inflation risks, a rating agency downgrade, an unexpectedly weak Treasury bond auction, continued tariff uncertainty, a spending bill that looks unlikely to rein in the deficit, and comments by a major bank executive about bond market stability.

Inflation risks have waned but remain top of mind for the Fed given Trump’s tariff plan. At its May 6-7 meeting policymakers cited increased uncertainty about the economic outlook and rising risks of both higher unemployment and higher inflation. While CPI has cooled to 2.3% in the most recent reading, it remains above the Fed’s 2% target.

On May 16, Moody’s finally joined its rating agency brethren Standard & Poors and Fitch Ratings in downgrading US sovereign debt from AAA to AA (S&P had done so in 2011 and Fitch, in 2023). Moody’s cited large fiscal deficits, the growing debt burden, rising interest costs, and – perhaps most importantly – Congress’ apparent inability to enact measures to rein in deficits.

A few days later, what was expected to be a standard debt auction did not attract nearly enough demand, leading to a higher yield. The Treasury held an auction to sell $16 billion of 20-year Treasuries. The prior six auctions (they are auctioned monthly) sold for an average yield of 4.76%, and all were below 4.91%. This time, the government had to raise the yield to 5.05% to sell all the bonds.

The next day, the House passed a tax bill that is anticipated to increase the federal deficit by $3.8 trillion over the next ten years, according to the Congressional Budget Office.

Tariff uncertainty continued during the month, with auto tariffs extending to engines and parts, a 100% tariff on foreign films, and (after markets closed on May 30) a doubling of steel tariffs from 25% to 50%.

To cap off the month, on Friday May 30, J.P. Morgan CEO Jamie Dimon said, “You are going to see a crack in the bond market, okay? It is going to happen.”

Taking a longer-term view, despite the gyrations in May, higher yields is a trend that has been unfolding for several years. Further, it’s been happening in most developed markets, not just the US. Since the beginning of 2022, the US 10-year Treasury yield has increased by 2.16%, the UK 10-year by 3.51%, the German 10-year by 2.39%, and the Canadian 10-year by 1.48%. Even in Japan, long ravaged by deflation and negative interest rates, yields have increased: the Japanese 10-year yield has increased by 1.44%.

Why are bond yields increasing globally? Largely for the same reasons as in the US: fiscal deficits, rising debt-to-GDP ratios, and persistent inflation. Currently, the US fiscal deficit is about 6.4% of GDP; Canada is running about 1.5%, the UK is 5.1%, and Germany around 2.7%.

Longer-term interest rates are also higher than in recent years because the term premium (the extra yield bond investors demand for holding a longer-term bond instead of stringing together a series of shorter-term bonds) has finally turned positive – after eight years of a negative term premium, which had been driven down by persistently low inflation and growth expectations.

Although the rise in bond yields globally over the past three years seems dramatic and unnatural, taking an even longer-term view illustrates that it was in fact the zero-interest rates years following the Global Financial Crisis that was the aberration. Today’s 4.4% 10-year yield is quite comparable to the range that the 10-year yield traded in for most of the first decade of the new century. The unusually low rates we saw in the 2010s – and especially the extremely low rates during the pandemic – were the outlier.

If interest rates stay higher for longer, what does this mean for investing? Higher rates are reflecting higher uncertainty as well as higher inflation. In a more uncertain and higher inflationary environment, we believe that equities are likely to outperform bonds, since companies have built-in hedges against inflation – after all, they price and report profits in nominal terms. We believe the sectors that are relatively less interest-rate sensitive should also do better – particularly those that have revenue outside the US, given the US dollar has recently fallen into a negative trend against other major currencies. In fact, this may be one reason that the Magnificent Seven has regained some strength – those companies average 51% of revenue from outside the US, versus 28% for the average S&P 500 company. We believe companies in a net cash position will fare better than companies with high indebtedness in a higher interest rate environment, because servicing that debt will become more expensive. Finally, real assets, such as real estate, infrastructure, and commodities have historically performed better in higher interest rate environments.

Disclosures