07.05.25 - Fed flags stagflation risk

As expected, the US central bank Fed holds interest rates steady at a range of 4.25% to 4.5% for the third straight meeting. Jerome Powell mentioned that the “uncertainty about the path of the economy is extremely elevated and that the downside risks have increased. The central bank also noted in its statement that the risk of higher unemployment and higher inflation has risen.
Jerome Powell further mentions that the central bank is not in hurry to cut interest rates and could wait and see the impacts of tariffs to the economy.

Following the Fed Press Conference, a report is saying that Trumps will end chip export restrictions (not confirmed by now). The chip restrictions wer scheduled to take effect on May 15.
Earlier, President Donald Trump said to reporters that he would not lower tariffs on China as a condition to begin trade talks. This morning both sides, the US and China, announced trade talks starting coming Saturday.

Markets: In a volatile trading US markets closed higher, interest rates down with the 10-year yield at 4.27%, gold price drops together with the oil price (-2%) while US dollar gets stronger

My view: Markets initially rose in early trading following the announcement of US-China trade talks. However, they turned negative after the Fed's statement, before rebounding into positive territory on news of a potential lift on chip export restrictions.

At this stage, investors appear to be trading on rumors rather than facts. In speculative periods, such a regime can persist longer than expected. However, it may ultimately come to an abrupt and sharp end. The question is, how many warning signals investors are going to ignore. The damage of the economy is real, with corporates reduced or even stopped investing already at the time of rising uncertainties around tariffs, even before the official announcement with the tariff board on April 2.

At this stage, investors seem to be trading on rumors rather than facts. In speculative environments, such a regime can persist longer than expected. However, it may ultimately come to an abrupt and sharp end. The real question is: how many warning signs will investors continue to ignore? The economic damage is already evident. Many corporations had scaled back or even halted investments amid growing uncertainty around tariffs, well before the official announcement by the tariff board on April 2.
In contrast to the COVID pandemic, when corporations swiftly ramped up production backed by substantial government stimulus, today’s environment offers no such support. Instead, companies face persistent uncertainty, with no clear path forward.

This is exactly why, in my view, the recent V-shaped rebound is difficult to justify.

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