Stocks Rally in May as Tariff Fears Subside; Long Yields Move Higher

Fixed Income

Bonds hit a headwind in May as rates rose, but year to date, they have helped offset some of the volatility seen in stocks. See Table 2 for bond index returns for May 2025, Q1 2025, and YTD.

The 10-year U.S. Treasury yield closed at 4.01% on April 4 – the lowest closing yield level of the year as the flight to quality hit a crescendo amid tariff worries. However, a quick reversal in yields started to happen with rates moving above 4.4% during the middle of April before settling at 4.17% by the end of the month. May saw rates move higher once again, this time spurred in part by concerns about expanding debt under the “One Big Beautiful Bill Act,” and the 10-year U.S. Treasury rate ended May at 4.41.% More dramatically, the 30-year U.S. Treasury surged from April’s close at 4.66% to a closing high of 5.08% on May 21, before closing the month at 4.92%. Our expectation of a volatile rate environment has materialized so far in 2025, with the recent pressure on rates moving higher. The more rate sensitive parts of fixed income, like U.S. Treasuries, were hardest hit in May, while high yield rallied during a strong month for stocks. Munis have been the laggard in bonds so far this year. However, outside of munis and long-dated U.S. Treasuries, bonds have done their job this year with solid gains through May and offsetting some equity market volatility.

We maintain our long-standing position favoring credit versus pure rate exposure in this interest rate environment. We also believe the role bonds play in a portfolio – to provide stable cash flow and to help offset the volatility of stocks in the long run – has not changed. The volatility seen in bonds provides opportunities for active bond managers, and in our opinion, having an active bond management approach makes sense in this environment. Furthermore, rates remain elevated and provide attractive opportunities for bond investors.

Economic Data Highlights and Outlook

Jobs: The job market remained strong in April. Non-farm payrolls increased by 177,000, well ahead of expectations of 138,000. However, the prior month was revised to show more than 40,000 fewer additions than previously reported. The unemployment rate remained at 4.2%, as expected. Job openings dropped rather sharply in March to under 7.2 million from just below 7.5 million in February. Interestingly, layoffs also declined by 222,000 in March. This movement might have been an initial reflection of businesses pausing some of their hiring activity in light of the uncertainty around tariffs. At this point it looks like companies are slowing hiring, but they are not enacting massive layoffs. Due to the central role of consumers in the U.S. economy, we will continue to monitor job market data. Chart 1 shows the unemployment level and the number of job openings. Clearly the spread between these two measures has closed in recent years, and the job market is becoming more balanced between job seekers and jobs available.

Chart 1

Inflation: Inflation data leaned positive when reported in May. The Consumer Price Index (CPI), both core and headline, rose 0.2% in April when a 0.3% gain was expected. The year-over-year headline reading was 2.3%, which was better than expected and the prior month mark of 2.4%. The core CPI rose 2.8% on an annual basis, as expected. The monthly reading of the Producer Price Index (PPI) declined by -0.5% when a 0.2% increase was expected. The core PPI also fell unexpectedly for the month by -0.4% when a 0.3% increase was expected. Those declines led to lower annual headline and core PPI readings than the prior month’s levels. Declines in the inflation numbers likely reflect the significant decline in oil prices. (West Texas Intermediate Crude dropped more than $10 per barrel since the beginning of April.) The Personal Consumption Expenditures (PCE) Price Index rose by 0.1% on both a headline and core basis for the month, as expected. The annual increase in the PCE core price index, the inflation reading targeted by the Fed, showed a gain of 2.5% in April, down from the 2.7% annual increase in March. (For more specific data, please refer to the end of this report.)

Overall, we believe inflation continues to make progress toward the Fed’s stated goal of around 2% for the core PCE price index reading. We expect this path to be bumpy, and tariff concerns have increased inflation fears and expectations, but we will wait to see if a real change will develop regarding pricing data. Inflation data over the last couple of months has shown ongoing improvement. Chart 2 shows the core CPI and core PCE price indices and the recent improvements in those price level readings.

Chart 2

GDP: The second reading of Q1 2025 continued to reflect contraction during the quarter by -0.2% on an annualized basis. Estimates were at -0.3%, which was the same number as the advance release. We had been expecting some weakness due to a spike in imports as businesses stockpiled inventories in the first quarter ahead of anticipated changes in tariff policy. However, it was unwelcome news that economic activity declined after a solid year of expansion in 2024. The personal consumption component of Q1 GDP was weak and revised lower to 1.2% compared to expectations of 1.7% and the prior estimate of 1.8% on annualized rates. By comparison, the Q4 2024 personal consumption rate was 4.0%. We have consistently said it takes a lot to knock down U.S. consumers, but spending activity did slow in the first quarter as some of the tariff concern headwinds were building and much of the country experienced poor weather in January and February. We hope this turns out to be an anomalous GDP reading, and the current Atlanta Fed GDP Now estimate shows expected Q2 2025 to come in at a 3.8% annualized pace (as of May 30, 2025).

Consumer Confidence: One economic data point that has been heavily affected by the tariff discussions and resulting economic uncertainty has been consumer confidence. Consumers are clearly saying they are not as confident in 2025. The University of Michigan consumer sentiment reading has fallen dramatically in recent months. It is important to watch what consumers “say” in confidence surveys; however, we think it is more important to monitor what consumers “do,” meaning spending data. We will monitor whether this drop in consumer confidence translates into less spending by consumers in the months ahead. Chart 3 shows the consumer sentiment reading from the University of Michigan. It is remarkable to see how negatively consumers reacted to tariffs and the uncertainty that surrounded that event. As this chart shows, consumers have only been this negative a few times in the last 45 years. If some clarity develops around tariffs, it would not be a surprise to see consumer confidence start to rebound.

Chart 3

Other Economic Data Points: After back-to-back readings above 50 to start the year, the ISM Manufacturing survey has struggled. This reading declined to 48.7 in April, which was better than expectations of 47.9, but lower than the prior month of 49.0. This was the lowest reading for this index in 2025, and every reading in 2025 has been lower than the prior one. Unfortunately, that trend continued in May, with the reading falling to 48.5 — below the expectations of 49.5 — and marking a new low for 2025. The ISM Non-Manufacturing Index, which covers the much larger service industries in the U.S. economy, showed some modest improvement increasing to 51.6 from the prior level of 50.8 and expectations of 50.2. Slowing manufacturing and non-manufacturing activity has developed recently, which is another likely side effect of tariff uncertainty. Recall, ISM readings above 50 reflect expansion and those below 50 indicate contraction.

Housing data for April remained under pressure with interest rates generally higher. Housing starts, building permits, and existing home sales were lower than expected in April. However, the pace of housing starts did improve from March, but building permits and existing home sales were lower than the prior month. New home sales were an outlier, as April’s pace surpassed both expectations and the prior month’s levels. The leading economic indicators index slumped in April with a -1.0% monthly drop, matching estimates. Retail sales (ex auto and gas) slightly missed expectations (0.2% compared to 0.3%), but the prior month showed an increase of 1.1%, which was better than the previously reported 0.8% monthly gain. Consumers appear to have been pulling forward spending activity ahead of potential tariff price increases in March, and it will be interesting to see if the slump in confidence readings translates to lower spending moving forward.

After a couple of years of solid stock market gains with relatively little volatility, equity weakness to start 2025 was unsettling for investors. Volatility was amplified in April with the tariff announcement and the uncertainties that tariffs might cause. However, stocks bounced back strongly in May as some of the worst-case outcomes for tariffs seemed to have been removed (or at least postponed). While not pleasant, equity volatility is a normal part of doing business in the stock market. Focusing on market fundamentals, we see an economy that we believe will grow in 2025, a Fed that is cutting interest rates, a fairly reasonably valued stock market, and S&P 500 companies that are expected to grow their earnings in 2025 and 2026. We will watch closely (and do expect) to see revisions that lower earnings estimates in the months ahead, but we have not seen much damage to those so far. Uncertainty about tariffs has ushered in volatility, and our analysts and portfolio managers will monitor industries and sectors that might be impacted by tariffs as they are making portfolio decisions. However, some of the most feared outcomes regarding tariffs seem to have passed. We still want to see what actually gets implemented regarding tariffs versus the headlines that are relentlessly inundating investors. As always, we believe it is imperative for investors to stay focused on their long-term goals and not let short-term swings in the market derail them from their longer-term objectives.

Originally published June 4, 2025

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