-
Tariffs and recession fears have created conflicting outlooks in the market, Deutsche Bank says.
-
Investors expect both lower interest rates and higher inflation.
-
Meanwhile, stocks and bonds are signaling two different things.
Navigating the US market has been tough this year.
Between President Donald Trump’s tariffs, creeping recession uncertainty, and fears of higher inflation, the environment looks “ripe for a correction,” Deutsche Bank wrote on Tuesday.
Here are three signals the bank has flagged that could be pointing to a fresh correction in the stock market if reality doesn’t meet investors’ expectations.
Rate-cut views
Investors are pricing in a considerable reduction in interest rates this year, betting that the fed funds rate will drop 100 basis points by December.
But those views run counter to the market’s inflation projections. Deutsche noted that US swaps imply a 3.47% inflation rate over the next year, up from 3% in March.
Though the Fed may slash rates to revive a slowing economy, its central goal is to clamp down on inflation — in other words, rising price growth will likely encourage rates to stay higher for longer.
Fed Chairman Jerome Powell hinted as much in a speech this month, citing that tariffs could create a “challenging scenario.”
“In light of that, markets risk repeating a consistent error of recent years, in pricing a Fed that is much too dovish compared to what actually happens,” Deutsche wrote. “We saw that pattern in 2022, 2023, and 2024, where markets priced in a more dovish path for the Fed each year than the reality.”
Risk on, risk off
While calls for lower interest rates suggest that investors are gearing up for a tariff-induced recession, equities aren’t trading as if the economy is about to weaken, the bank said.
“For instance, the peak-to-trough decline in the S&P 500 (- 10.0%) is not on a scale consistent with any recent recession. Similarly in credit, US HY credit spreads closed at 368bps yesterday, which is some way from the peak levels even in non-recession scenarios,” Deutsche wrote.
It also noted that the slump in oil prices isn’t on par with previous downturns.
And yet, government bond yields tell a completely different story. Consider the 2-year Treasury yield, which remains at its lowest levels since October. When investors fear a downturn, yields tend to fall as buying picks up amid the flight to safe-haven assets.
“Given this dislocation, the risk is that if the data recovers and continues to point away from a recession, we could plausibly see moves similar to last summer, where yields moved higher pretty quickly as investors reacted to the reality of a more hawkish Fed and the absence of a recession,” Deutsche wrote.
The end of US exceptionalism?
Deutsche acknowledged that a clear divergence between US and foreign assets is justified, as tariff chaos has tarnished demand for US investments.
Investors have grown to question the safety of US Treasurys, leading to a jarring sell-off in early April. Meanwhile, the US dollar has touched a three-year low on the same premise, falling against a basket of rival currencies.
While some on Wall Street have taken this to symbolize a more permanent end to “US exceptionalism,” such outlooks leave these assets vulnerable to upside surprise.
“Indeed, the last week alone has already seen a partial reversal relative to the Euro’s peak on April 21. That came as Trump signalled he wanted to make a deal with China and said that he had “no intention” of firing Fed Chair Powell,” Deutsche noted.
Read the original article on Business Insider
