"I don't know whether I'm happy in the rain—or miserable in the sun."
The 2nd quarter of this year began with President Trump’s “Liberation Day,“ referencing the rollout of aggressive new trade tariffs aimed at narrowing the US trade deficit. The measures, more severe than even the worst-case forecasts, ignited a global market selloff that erased $6.6 trillion in US market value—the largest two-day loss on record.
Fast forward to the end of the quarter, the stock market not only recovered all of those losses but surged to fresh new highs. After plunging nearly 15% in April, the S&P 500 soared 24% by the end of June. The recovery took just 89 trading days, making it the quickest rebound from a decline of at least 15% on record, according to Dow Jones Market Data.
This recovery came despite escalating fears of a global trade war, violent conflict in the Middle East, stalled U.S. trade talks with key partners, and renewed political pressure on Federal Reserve independence.
The result is a striking juxtaposition: a record-breaking stock market amid rising economic and geopolitical uncertainty. Are investors irrationally exuberant in the face of growing risks? Or are headlines exaggerating the threats, fueling a negativity bias that clouds what might be a more resilient economic backdrop than many realize?
U.S. inflation cooled for three consecutive months from February through April, as economic uncertainty prompted Americans to scale back spending. Personal savings rose during that stretch, climbing from 4.2% in January to a peak of 4.9% in April.
That trend has now reversed. In June, headline inflation rose 2.7%, while core inflation—which excludes food and energy—climbed 2.9%. Analysts broadly agree that tariffs are starting to show up in the data. Daniel Hornung, senior fellow at MIT and former deputy director of the National Economic Council, told USA Today: “This marks the first inflation report where tariffs are beginning to show up materially in key categories — from appliances and furnishings to apparel and groceries.”
New York Fed President John Williams estimates that tariffs could add as much as 1% to inflation by late 2025 or early 2026. Apollo’s chief economist, Torsten Slok, forecasts that inflation could peak by November or December. Experts caution that the full effects of tariffs may not be fully reflected yet, as many importers front-loaded goods before the duties took effect.
Looking ahead, several forces may keep inflation elevated. Businesses are increasingly passing on tariff costs to consumers. Wage growth remains strong at nearly 4%, immigration restrictions continue to tighten labor supply, consumer spending is rebounding, and adverse weather—from Midwest droughts to floods in Asia—is driving up agricultural prices.
On July 7, President Trump extended the tariff pause to August 1, while China’s deadline remains set for August 12. If no trade deals are finalized by then, tariffs will snap back to elevated, country-specific reciprocal rates.
Progress has been uneven. The European Union—whose trade with the U.S. exceeds $5 billion daily—believed a deal was near, only to face new demands from the Trump administration. This has prompted a more combative stance from Germany, the bloc’s largest economy. Berlin has signaled support for the EU invoking its Anti-Coercion Instrument (ACI), a legal mechanism that could authorize aggressive trade and investment restrictions as a last resort.
Meanwhile, U.S.-China talks appear more constructive. The two nations reached a preliminary agreement in June, and both sides have expressed optimism about meeting the deadline. Notably, China’s rare earth exports surged 32% in June, hinting that early progress may already be yielding economic results.
Talks with Canada and Mexico remain turbulent. While both nations have long depended on U.S. trade, companies in each country are now exploring ways to reduce that reliance. One major initiative: a proposed “Northern Corridor” trade route between Canada and Mexico that would bypass U.S. tariffs altogether.
In Japan, an agreement with the U.S. faces fresh uncertainty. Prime Minister Ishiba—who has spearheaded negotiations—may be ousted after his Liberal Democratic Party (LDP) coalition lost its majority in the upper house, following a similar loss in the lower house last fall. Political instability could stall or unravel progress.
Perhaps the most contentious front is Brazil. Despite the U.S. holding a trade surplus with the country, Brazil is a critical supplier—accounting for 23% of U.S. beef imports, and leading in key food commodities like coffee and orange juice. With no bilateral talks currently underway, Brazilian officials have acknowledged that a deal may not be reached in time.
It’s not just uncertainty around future trade policy that is clouding the Fed’s inflation outlook. The Fed also finds itself mired in a political chess match with the White House. Criticisms posted on Truth Social and alleged conversations amongst legislators behind closed doors has intensified scrutiny around the Fed’s next move.
In early July, Fed Chair Jerome Powell acknowledged that had it not been for the President’s planned tariff hikes on imported goods, the central bank likely would have cut rates already. As it stands, a rate cut at the July meeting is highly unlikely, and markets are pricing in just slightly better than 50/50 odds for a cut in September.
With the S&P 500 trading at all-time highs, stock valuations have become increasingly stretched. The index is now trading above a 22x forward P/E multiple, over 10% higher than the 5-year average and 20% higher than the 10-year average. One notable driver behind this surge is the historically high allocation of US household financial assets allocation to stocks, now even exceeding the 2000 dot-com era.
Such valuations could be vulnerable in the event treasury yields turn higher, which may be triggered if the Fed disappoints the market on its number of rate cuts or if tariffs cause inflation to reaccelerate.
Another emerging concern is early evidence of labor market softening. Private sector hiring has been especially weak. Well-known payroll processor, ADP, reported that privately-run businesses created just 29,000 new jobs in May, the smallest increase in more than two years. June followed up with 33,000 decline in private sector jobs; the first monthly job loss since 2023. Additionally, continuing jobless claims have trended to their highest level since November 2021, signaling that laid-off workers are struggling to find new employment.
While markets have remained resilient amid the geopolitical and trade uncertainty, the second half of the year presents a more complicated outlook. Elevated valuations, a less accommodative Fed, and early signs of labor market softening all point to a market that may be more exposed to negative surprises.
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