Investors and the Fed Grapple With Uncertainty

Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.

The major equity indices notched modest gains in turbulent trading last week as investors continue to grapple with signs of a slowing economy, the fluid nature of trade policy and the uncertain effect tariffs will have on inflation and the pace of economic growth. The uncertainty investors have felt of late can be seen in the recent readings of the American Association of Individual Investors (AAII) sentiment survey, which shows that bullish perceptions of the market for the coming six months have hovered around 20 percent or less in each of the past four weeks, while bearish sentiment has averaged just shy of 59 percent during the same period. For context, bullish readings have averaged 37.5 percent since its start in 1987, and bearish readings have averaged just 31 percent.

However, it’s not just investors who are feeling uncertain about how things will play out. Last week the Federal Open Markets Committee (FOMC) released its Summary of Economic Projections (SEP), or so-called “dot plot.” While the SEP has limited value for predicting actual Fed activity, it can be useful as a real-time snapshot of how members of the FOMC view conditions now and their base case of how things might evolve.

Last week’s release showed that the committee still expects to cut interest rates twice this year; however, that view is not unanimous. The number of members who expect to hold rates steady has risen from just one in the SEP last December to four in the most recent version. Indeed, Fed Chair Jerome Powell’s comments during his press conference also underscored the challenge the Fed faces in forecasting how inflation and the economy will evolve in the coming months given the uncertainty surrounding the economic impact of announced tariffs and the risk for further trade escalation with major trading partners. Although the latest SEP showed inflation ending 2025 higher and the pace of economic growth lower than the FOMC projected at the end of last year, Chair Powell noted that the projections are “based on what each participant judges to be the most likely scenario going forward—an admittedly challenging exercise at this time."

As we noted in last week’s commentary, investors have been holding out hope that either the Federal Reserve or President Trump would act to prop up the economy and markets should selling pressure gain momentum. These so-called “put options” would take the form of either rate cuts by the Federal Reserve or the president dialing back on his tariff plans. With Chair Powell’s comments last week that the Fed still has room to stay on the sidelines while it monitors how the Trump administration’s trade policy plays out, we believe it is unlikely the “Fed put” will materialize anytime soon. Furthermore, while President Trump noted late last week that there could be some flexibility in plans for reciprocal tariffs charged on imports, no details were included with the statement, so it remains unclear whether potential tweaks to trade policy will provide the relief investors have been seeking. For these reasons, we believe elevated uncertainty is likely to persist during the coming months.

While uncertainty can be uncomfortable, it doesn’t mean investors need to pull out of the market due to fears of a worst-case scenario. Instead, the current environment serves as a valuable reminder that an unpredictable future will lead to unpredictable opportunities for investors in the intermediate and long terms. And capitalizing on these unforeseen opportunities is best done through diversification.

Conversely, investors who sell during periods of volatility help to create opportunities for extra returns for those who stay true to their asset allocation. While we believe uncertainty will remain elevated for a while, we also believe the best way to address it is by focusing on the long term and staying diversified to avoid concentrating too much on any one market segment or asset class.

Wall Street wrap

Consumers not in buying mood: The latest retail sales numbers from the U.S. Census Bureau show that consumer spending grew last month, with overall retail and food service sales rising 0.2 percent in February. The rise was weaker than Wall Street expectations and comes as January’s sales estimates were revised lower, to a decline of 1.2 percent.

Growth was limited, with five of 13 categories registering increases. Overall retail sales are up 3.1 percent year over year on a seasonally adjusted basis. Still, the Control Group (which is a proxy for the spending measure found in gross domestic product growth) was up 1 percent for the month, which beat Wall Street expectations and marked a reversal of the prior month’s 1 percent decline.

Forward-looking indicators point to headwinds: The latest Leading Economic Indicators (LEI) report from the Conference Board weakened but points to some stabilization of growth ahead. The February LEI reading fell 0.3 percent after January’s final reading showed a decline of 0.2 percent. The reading is now down 2 percent on an annualized basis over the past six months, weaker than the six-month annualized decline of 1.8 percent reported in January. The data paints an improving picture over the past six months, but the narrowness of improvement is cause for concern with the six-month diffusion index (the measure of indicators showing improvement versus declines) registering 50 percent, down from last month’s downwardly revised 60 percent reading and in line with a level that typically is viewed as a warning sign for economic growth. A downturn in consumer expectations weighed most heavily, followed by a decline in new orders for manufacturers. While recent readings mark an improvement from levels seen last year, they still suggest economic growth is slowing. In comments released with the latest data, Justyna Zabinska-La Monica, senior manager, Business Cycle Indicators at the Conference Board, noted, “Given substantial policy uncertainty and the notable pullback in consumer sentiment and spending since the beginning of the year, we currently forecast that real GDP growth in the U.S. will slow to around 2.0% in 2025.”

Existing home sales rise on better inventory: The National Association of Realtors (NAR) reported that existing home sales in the U.S. rose 4.2 percent in February to a seasonally adjusted annual rate of 4.26 million units. Despite the monthly increase, sales were down 1.2 percent from year-ago levels, breaking a streak of four months of year-over-year gains. The inventory of available homes grew by 5.1 percent in February to 1.24 million units, or about 3.5 months of supply.

Details of the latest sales figures show that the housing market continues to be tilted toward the high-priced units, with the upper end of the market showing strong gains as sales of less expensive units lag. Sales of properties above $1 million rose 11.5 percent from year-ago levels. Mean transactions for houses valued at $250,000 or less declined year over year. While this trend has persisted for a while, the latest report shows some moderation in the imbalance despite mortgage interest rates remaining elevated. We will be watching to see if the market is beginning to even out or if February’s data is simply statistical noise.

The latest data shows little progress on the issue of affordability. The median price for existing homes came in at $398,400, up from the prior month and 3.8 percent higher than in February 2024.

Homebuilders’ confidence dips: Homebuilder confidence fell in March due to concerns about tariffs and higher construction costs. The latest reading from the National Association of Home Builders survey shows confidence dropped to 39 in March, down three points from February and now at the lowest level in seven months.

While views of current conditions fell to 43, down three points from the prior month, sales expectations over the coming six months held steady at 47. As optimism has faded in recent months, the portion of builders cutting prices has risen, with 29 percent of respondents reducing prices (up from 26 percent in February). The average price cut was 5 percent in March, unchanged from February.

The week ahead

Monday: We’ll get an update on the health of manufacturing and services in the U.S. when S&P Global releases its Flash Purchasing Manufacturers Index reports for March. Services fell into contraction last month, while manufacturing slowed but remained in expansion territory. We will be watching to see if the weaker reading for both sectors was a temporary blip or if uncertainty is beginning to hurt the pace of economic activity.

Tuesday: The Conference Board’s Consumer Confidence report for March comes out in the morning. Last month’s report showed a drop in confidence. Given the Federal Reserve’s ongoing focus on the employment picture, we will continue to focus on the labor market differential, which is based on the difference between the number of respondents who believe jobs are easy to find and those who report challenges in finding work.

We’ll be watching the S&P CoreLogic Case-Shiller Index of property values covering January. Prices overall have moved higher, albeit at a slower pace, in the past several months. We will be looking to see if home prices continue to rise.

Wednesday: Data on durable goods orders for February will be released to start the day. We’ll be watching for signs of the direction of business spending in light of signs of growing uncertainty and slowing economic growth.

Thursday: The Bureau of Economic Advisors will release its third estimate of gross domestic product growth for the fourth quarter. We will be looking for any significant divergence from the initial reading.

Friday: The February Personal Consumption Expenditures Price Index from the Bureau of Economic Analysis will be out before the opening bell. This is the preferred measure of inflation used by the Federal Reserve when making interest rate decisions. We’ll be monitoring to see if the latest data shows signs of progress in the disinflation process.

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