By Brian Johnson, Director of Investment Services

2025 kicked off with speculation and uncertainty about how the economy and market would respond to a new political landscape and prospective policy changes. Now entering the third month of the year, we’ve seen the markets begin to digest recent data releases suggesting some downside risks to the U.S. economy, along with additional uncertainty related to future policy changes across several fronts.

One economic data point that led to market shifts during the first few months of the year was consumer confidence. The Conference Board’s Consumer Confidence Index fell to 98.3 in February, down seven points from 105.3 in January. That decline represented the largest monthly fall in consumer confidence since August of 2021.

Personal Consumption Expenditures (i.e., consumer spending) is the largest component of U.S. gross domestic product (GDP), representing nearly 70% of overall GDP on an annual basis. With the U.S. consumer being such a critical component of economic growth, future growth considerations will undoubtedly be heavily influenced by consumer behavior.

One factor playing a role in consumer confidence is ongoing tariff negotiations. Respondents to the Conference Board’s February survey noted concerns around inflation and uncertainty of a trade war impacting prices. The survey’s results also represent a shift from the end of 2024, where consumer confidence remained elevated and holiday spending numbers matched that confidence.

Retail sales fell more than economists expected in January, dropping 0.9% from December versus expectations of a 0.2% drop. Part of the larger drop was due to December’s number being revised higher after a stronger than expected holiday season. February and March retail sales releases will provide further insight into whether the fall in consumer confidence is spilling over into consumer behavior.

The Federal Reserve’s Federal Open Market Committee (FOMC) left its key federal funds rate steady at 4.25% – 4.50% at their meeting on January 29^th. The decision to leave rates unchanged follows three consecutive FOMC meetings where the fed funds rate was reduced, dating back to September of 2024. Following that January FOMC meeting, Chair Jerome Powell noted that “labor market conditions remain solid, but inflation remains somewhat elevated.”

While the most recent employment data from February came in weaker than forecast, it did improve upon the numbers from January. Non-farm payrolls increased by 151,000 during the month, falling below the forecast of 170,000, but improving on the downwardly revised 125,000 new jobs created in January. While the February non-farm payroll number fell below expectations in February, the improvement over January reflects the stability in the labor market noted in the FOMC’s most recent statement on employment.

As it pertains to inflation, the Consumer Price Index (CPI) cooled modestly to 2.8% in February, down from 3% in January. The FOMC’s preferred measure of inflation, the Personal Consumption Expenditures (PCE) index, also eased in January to 2.5%. While the most recent prints on inflation show signs of progress towards the FOMC’s target of 2%, market uncertainty remains around policy shifts, such as tariffs, and the impact those might have on the broader economy.

The FOMC has reiterated it will remain data dependent when deciding the course of future monetary policy. Even with persistently sticky inflation (at least above the Fed’s stated threshold), market expectations are for the FOMC to cut their target rate one or more times in 2025, with the probability of a quarter-point cut at their meeting in June now coming in above 50%, per CME’s FedWatch Tool. The FOMC is scheduled to meet six more times the remainder of this calendar year – next in early May. Future economic releases on inflation and employment will be key in how the FOMC looks at interest rate policy for the remainder of 2025.

Looking beyond cash and overnight rates that largely track the fed funds rate, we’ve seen yields fall across longer tenors of the yield curve since the start of the year. As of the writing of this article, the 2-year U.S. Treasury rate was down over 25 bps from where it opened the year, falling below 4% for the first time since last October. The 3-year, 5-year, and 10-year U.S. Treasuries are also down anywhere from 20 – 30 basis points from where they opened trading in 2025. Global investors flock to safe havens such as U.S. Treasuries during periods of economic uncertainty, and the current drop in U.S. Treasury yields is likely evidence of that “flight to quality” taking place over the past few weeks. There continues to be a good amount of volatility in interest rate markets as those participants attempt to digest the continuous vacillations in global trade policy.

As we continue to assess the factors that might impact the interest rate environment and FOMC decisions over the coming months, we continue to stress the benefit of building diversified investment portfolios that can weather various economic and business cycles. Targeting a long-term investment strategy is a great way to build cash flow stability for your entity’s operating needs in today’s marketplace and for years to come.

If you’re interested in discussing different portfolio strategies, please contact your Ehlers Investment Adviser to learn more.

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