In the first month after November's Election Day, the Standard & Poor's (^GSPC) stock index surged 5.3%. Investors cheered incoming President Donald Trump, who has promised fiscal stimulus in the form of tax cuts, business-friendly deregulation and other measures that could boost corporate profits.
However, the S&P 500 has fallen 4% since December 6 as investors worry about Trump's "America First" agenda. Trump hopes tariffs on imported products will push up prices, while Trump's plan to deport immigrant workers could drive up labor costs. That has raised fresh concerns about a second wave of inflation, while the first wave, which peaked in 2022, appears to be fading.
Markets are likely to welcome Trump's inauguration on January 20 as it will end 10 weeks of speculation about his policies and begin to provide clarity on his actual plans. But the market has sent some key signals that Trump would be wise to heed.
Citi economists recently wrote in their 2025 outlook: "Trump's policies have created a complex mix of favorable and unfavorable supply shocks and demand shocks. All in all, the uncertainty surrounding Trump's policies is substantial."
Of course, markets hate uncertainty, but they were suddenly plunged into it.
The Economic Uncertainty Index maintained by economists Scott Baker, Nicholas Bloom and Steven Davis jumped in November from 109 in October of 225, the highest level since 2022. In December, the index fell to 215, still well above average.
Tom Lee of investment firm Fundstrat said in a video analysis on January 12 that "2025 has been tumultuous" so far. "There's policy uncertainty in the incoming White House. These are the obvious things: tariffs and deportations."
The Federal Reserve is also on edge. Minutes of the Fed’s December meeting showed that “all participants agreed that there was increased uncertainty about the scope, timing, and economic impact of potential changes in policy affecting foreign trade and immigration.”
If investors and policymakers are confused, it may be because Trump and his team are sending mixed signals. Some of Trump's advisers have fueled media reports that Trump is planning to reduce tariffs. Trump himself refuted this in social media posts. Wall Street is splitting into two camps: those who expect minimal disruption to trade and those who expect greater disruption.
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The market expressed some specific concerns.
One is that Trump’s tariffs will push up prices and trigger severe inflation. In the latest monthly survey from the University of Michigan, consumers' expectations for future inflation rose sharply, likely because people heard about Trump's new tariffs. “Consumers are increasingly concerned about the potential stagflationary impact of President-elect Donald Trump’s policy plans,” Capital Economics explained in a Jan. 10 analysis.
Investors appear to share the same concerns, which may help explain the unusual swings in interest rates.
The Fed has cut short-term interest rates by a full percentage point since September. But since then, the 10-year Treasury rate has risen by just over a percentage point, a highly unusual difference.
"Markets may be adjusting to a more unstable, inflationary and debt-laden future," Moody's Analytics explained in a Jan. 13 analysis.
If inflation picks up again, the Fed will have to end the rate-cutting cycle it started four months ago. Many investors now believe this scenario is likely to happen. CME Group's FedWatch tool shows that markets have been pricing in higher short-term rates since Trump was elected in November, and especially since early January.
Trump is not the only factor. A strong jobs report in December showed the economy is running strong and further interest rate cuts may not be needed. But that’s on top of worries that Trump will trigger a new round of inflation.
Higher interest rates can affect stocks in a number of ways. When fixed-income rates move higher, bonds become more attractive relative to stocks, and some investors will sell stocks and buy bonds. Higher interest rates also push down profits as it becomes more expensive for companies to borrow, which could cause some stocks to fall in value.
For example, if Trump hints that tariffs will be imposed on imports from China, Mexico, Canada and other trading partners, he may change his rhetoric after taking office. He could also limit deportations to specific immigrant groups, such as convicted criminals, which could signal he doesn't plan to deport workers. Some investors remain optimistic about the investment climate under Trump, expecting his threats to be worse than his actions.
But it may take some time for the fog to clear for Trump, as he may look to use tariffs and the threat of deportations as leverage in various negotiations that could take months. So he may not show his hand right away. What the market is telling Trump is that he should avoid any inflation.
They haven't said how patient they are willing to be.
Rick Newman is a senior columnist Yahoo Finance. follow him blue sky and X:@rickjnewman.
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