Catnip Bounce or Market Bottom ?

Markets rebounded sharply despite worsening economic signals, leaving investors questioning whether this is a short-lived rally or a true bottom. Inflation remains sticky, consumer sentiment is falling, and tariff uncertainty continues to unsettle businesses. The Fed remains cautious, with rate cuts unlikely in the near term. Meanwhile, European and Chinese markets are gaining traction, and gold is holding strong as a safe-haven asset. With key economic data ahead, volatility is set to continue.

Market Overview

Markets entered last week on edge, with fears of an escalating trade war, a renewed spike in inflation expectations, and growing signs of risk aversion in credit markets. By Friday, the University of Michigan’s Consumer Sentiment Index reinforced all those concerns, plunging to 57.9, the lowest reading since November 2022. That was jarring enough, but what really caught my attention was the spike in long-term inflation expectations, up by the most since 1993 to 3.9%, alongside a steep fall in personal finance expectations.

This is exactly what the Federal Reserve has been trying to avoid—once inflation psychology sets in and fears over economic insecurity grow, the consumer will retreat, and that becomes difficult to reverse. Nearly half of respondents mentioned tariffs unprompted, a clear sign that consumers are no longer treating them as background noise but as a real economic threat.

For markets, this should have been a sell signal. Instead, equities surged more than 2% on Friday, closing at session highs. I was tempted to go with the eponymous ‘dead cat bounce’ as both the title of this Weekly and a way to describe the move, but instead, I settled on ‘the Catnip Rally’—one where investors get excited, but the high doesn’t last. That said, hindsight could still confirm this as the bottom, though I have my doubts. We are far from through the Tariff Wars, and history suggests that these kinds of rebounds need confirmation before being taken seriously.

Part of the rally was technical. Stocks had entered correction territory, with the S&P 500 down more than 10% in three weeks, setting up a natural reversal. Dip buyers played their part, but so did politics. The Senate approved a funding bill, avoiding a government shutdown, and for once, Trump made no new tariff threats. Whether that silence was intentional or not, markets took it as a reprieve. But the real question is whether this was a genuine turning point or just another short-lived bounce. The answer will depend on how markets react when the next wave of tariffs is announced in early April.

For those tempted by a bit of dip buying, there are some things to consider. On the plus side, Friday ticked some early boxes for a comeback. The bounce was broad, with NYSE upside volume just shy of 90%, and it broke an unusually persistent downtrend. The S&P 500 hadn’t closed above its five-day moving average all month until Friday.

Constructive, but not decisive. As mentioned, the move came despite the grim University of Michigan consumer sentiment report, suggesting that the recent selloff had already priced in deteriorating sentiment. For a deeper pullback from here, we’d need hard evidence of a faltering economy, not just negative survey data.

Markets bottom in processes, not moments. Snapback rallies are common but always need to prove themselves. The S&P 500 closed at 5,638, still well below its peak. To reach its 200-day moving average, it needs to climb another 1.8%. Historically, fast 10% drops tend to be short-lived, and every time we’ve had a decline this swift, markets were higher three, six, and twelve months later. Let’s see if the market can hold its ground when tariff threats return. Friday’s rally happened in rare silence; let’s see how it handles the next round of noise.

Even so, perspective is key. Just a few months ago, the dominant market narrative was unfettered US exceptionalism – now – the pendulum has swung in the opposite direction, with many assuming that Trump’s policies will derail growth entirely. These kinds of rapid shifts rarely reflect level-headed analysis. There are still reasons to remain constructive. Interestingly, while top-down earnings forecasts based on broad macroeconomic assumptions have deteriorated, bottom-up earnings estimates, built from company-level data, remain relatively strong. If the company-level data holds up, that alone could provide some reprieve for markets.

Alongside tariff fears – or perhaps because of them – the thing that keeps me up at night is the increasing odds of a slowing US economy. Recessions and bear markets have a well-documented correlation. Since the end of World War II, eight of the ten bear markets have coincided with recessions, and right now, growth momentum is fading fast. The inflation fight is far from over, but the bigger risk could be that the Fed remains too focused on inflation and underestimates the slowdown already unfolding.

The central bank is trapped between a deteriorating economic backdrop and inflation that refuses to fade. While recent data shows some cooling in price pressures, the persistence of inflation in services, particularly in shelter and wages, is complicating the picture.

Inflation

The latest inflation data added to the complexity. The Consumer Price Index (CPI) report had a positive surprise, with headline inflation coming in lower than expected at 2.8%, down from 3.0% the prior month. Core inflation also undershot forecasts, falling to 3.1%. On the surface, this was good news, but traders weren’t buying it. Market reaction was muted, with short-term bond yields rising slightly and rate cut expectations barely budging. The reason? The same old story that services inflation remains sticky, with shelter and healthcare costs still running hot. The drop in airfares helped the headline figure, but volatile components like this don’t shift the bigger picture. The trimmed mean and median CPI measures from the Cleveland Fed and the Atlanta Fed’s sticky-price index all suggest that underlying inflation pressures are still too high for comfort.

Unfortunately, the bar for a Fed rate cut remains high if one looks at the data. One-year inflation ‘break evens’ derived from bond markets now suggest inflation will hit 4% over the next year and average 3% over the next two. If those numbers prove accurate, it’s difficult to see the Fed cutting rates aggressively without more convincing evidence that inflation is on a sustained downward path. Or if they are forced into rapid action by a rapid deterioration in the economic picture.

Additionally, policymakers are keen to avoid repeating their mistakes from 2021 when they dismissed early inflation warnings as transitory. That misstep makes them more likely to err on the side of caution now. The situation in Brazil serves as a cautionary tale – after cutting rates too early, the central bank is now being forced back into a hiking cycle as inflation reaccelerates. The Fed won’t want to make the same mistake.

Credit Spreads

One thing to keep an eye on is what the credit markets are telling us and the widening in spreads is becoming harder to ignore. The move is less about Fed policy flexibility and more about markets quietly pricing in a slowing economy and rising default risks. Historically, when spreads start creeping wider like this, it’s an early warning sign that economic momentum is stalling. Investors are becoming more cautious, shifting away from riskier bonds and demanding higher compensation for holding corporate debt. It’s not a full-blown panic, but these moves tend to show up before the real stress does. If spreads keep widening, it won’t just be a credit market issue – it’ll be another red flag that a recession is creeping closer.

Europe and the UK

Outside of the US, the key question is whether recent optimism is durable. European stocks largely avoided the US selloff earlier this year but fell in tandem with Wall Street last week. Investors recognise that a genuine US slowdown would inevitably hit Europe’s growth, particularly if Trump follows through on his threat to impose 200% tariffs on European wine and spirits. Even with the dollar’s recent slide, it remains historically expensive on a trade-weighted basis, suggesting that capital flows out of US equities into European assets still have room to run. However, Europe’s ability to sustain its fiscal expansion could be more limited than expected. Outside of Germany, most European nations have little room to take on additional debt, meaning the boost to growth could be shorter-lived than hoped.

The UK has been a relative bright spot, though the government’s fiscal stance is more constrained than its European peers. While a defence spending push was expected to be expansionary, Downing Street seems more focused on funding military initiatives through spending cuts rather than new borrowing. Given Britain’s significantly higher interest rates and lower borrowing headroom compared to Germany, this approach makes sense, but it also limits the immediate economic benefit. The Treasury’s spring statement later this month may provide some clarity, but early indications suggest that any additional spending will likely be offset by new (likely measured) tax hikes.

China

Another bright spot has been the performance of Chinese equities, with optimism building as Beijing ramps up efforts to hit its 5% growth target. With fresh stimulus measures expected, investors increasingly believe policymakers will step in as needed to keep markets moving higher.

The shift in sentiment is clear. Global investors have been moving money into Chinese equities for three straight weeks, with inflows hitting their highest levels since early 2023. JPMorgan has processed record currency conversions into Hong Kong dollars and yuan, suggesting renewed demand for local stocks. Earnings expectations are also improving, with MSCI China forecast to grow profits by 10% over the next year, albeit still trailing the S&P 500’s projection but offering better value at just 11 times forward earnings, compared to 20 times for US stocks.

That said, years of government crackdowns and a property sector meltdown mean many long-term investors remain understandably wary. Deflationary pressures linger, and some are waiting for stronger signs that China’s private sector is regaining its footing. The bigger question is whether China’s recovery is driven by policy or genuine economic momentum, and the latter will be what truly sustains the rally.

Gold

As if the case for portfolio diversification needed any more impetus, Gold has been another standout this year, breaking through the $3,000 per ounce mark last week and holding firm even as equities rebounded. Safe-haven demand remains a key driver, particularly with ongoing tariff uncertainty and rising inflation expectations. Central banks have also been strong buyers, led by China and several emerging markets, reinforcing the notion that Gold is a necessary hedge in today’s environment.

While some market participants question whether Gold can sustain its rally, the fact that it has remained elevated despite shifting risk appetite suggests that investors still see a need for protection against economic and geopolitical instability. With policy uncertainty persisting, Gold’s resilience may signal that broader market risks are not yet fully priced in.

Where from here?

Taking a step back from the crazy short-term news, looking forward past Tariff tantrums, Trump will be itching to give the voters some good news, and I can but presume he is already laying the groundwork for his next big move – stimulus. With Republican lawmakers facing pressure from nervous constituents, Trump promised to take a more measured approach to spending cuts this week. The real game-changer, though, could be his long-promised tax cuts. While the Continuing Resolution bill didn’t contain them, its passage was necessary to pave the way for Trump’s planned tax package, which he aims to push through by August.

And to finish another area where we might get some good news, although it would seem not any time soon as the Russia-Ukraine standoff remains deadlocked, with Putin stalling on a ceasefire while demanding concessions Ukraine and the West won’t accept. Trump has pushed for a quick truce, but Moscow insists on ‘underlying issues’ being resolved, which means Ukraine giving up land, accepting neutrality, and demilitarising. Keir Starmer is still keen to help in the process and is pushing Western allies to ramp up economic pressure, calling Putin’s delay tactics a sign he isn’t serious about peace. A ‘coalition of the willing’ is discussing a possible peacekeeping force, though Russia refuses to accept NATO troops in Ukraine. Western officials believe Putin is playing for time while keeping unrealistic demands on the table. Starmer has warned that the West will increase economic pressure unless Russia shows real intent. For now, the war remains at an impasse.

This Week…

This week looks like being just as busy on the news flow front! There will be a Fed meeting on Wednesday, with odds of a rate cut slim, but not zero. Markets think it is more likely in June. We also get crucial Retail Sales data, where we might see further signs of the consumer retreating. If nothing else, I can promise you that volatility will remain elevated!