President Donald Trump is attempting the most sweeping transformation of government and policy in decades. The White House is moving furiously to slash spending, expand tariffs, repeal regulations and rewrite tax rules. A lot of people are wondering what it all means for the economy, jobs, housing, inflation and the stock market.
The truth is no one knows. But the best guess lies in the collective wisdom of markets — the countless independent buy and sell decisions manifested in stock and bond prices.
Michael Mauboussin, an investment strategist and adjunct professor at Columbia Business School, simulates this collective wisdom for his class every year by asking students to guess the number of jellybeans in a jar. Posting the latest results on X, Mauboussin reported that “the individual guesses were off by 50%, on average, but the average of the group was within 0.1%.” In other words, “The crowd is smarter than the average person in the crowd.”
You can think about markets as a bespectacled business professor aggregating guesses about asset prices rather than jellybeans — except there is vastly more information in stock and bond prices. Each price is a window into a specific investment, but read together, asset prices tell a broader story about the direction of the economy and the forces behind it, including monetary policy, business activity and government policy.
So, here’s a brief tour of the prices I follow and what they’re telling me now.
I start with the 10-year US Treasury yield to get a general sense of the mood. A rising yield suggests a strengthening economy, possibly coupled with higher inflation, while a declining one hints at a slowdown. The 10-year yield is down 0.6 percentage point to 4.2% since mid-January, a big move in a short time that indicates the economy may be slowing.
If so, markets should also expect the Federal Reserve to lend support by lowering short-term interest rates — and they do. The two-year Treasury yield closely tracks the federal funds rate — the overnight bank lending rate the Fed uses to set short-term rates — and often anticipates the central bank’s next move. The two-year hung around the fed funds rate for several months beginning in November, correctly signaling that the Fed would pause its rate-cutting campaign. Since mid-February, however, it has dipped 0.4 percentage point to 3.9%, projecting that the Fed will cut rates at least one more time this year. It’s yet another sign of a slowing economy.
The next place I look is credit spreads, or the difference in yield between corporate bonds and Treasuries with similar maturities. Investors generally demand a higher yield for lending to companies than to the US government. But how much more depends on investors’ confidence that companies can service their debt, which depends in large part on the strength of the economy.
Credit spreads are surprisingly subdued. The premium BBB-rated corporate bonds offer over Treasuries is about 1 percentage point, near a historic low. For perspective, the spread spiked to 4 percentage points during the Covid pandemic and climbed to nearly double that during the 2008 financial crisis. So, unlike 10- and two-year Treasuries, spreads don’t seem to fear a slowdown, or at least not yet.
Stocks, on the other hand, aren’t as sanguine. A slowdown is a headwind for earnings growth, and the stock market seems to be bracing for some resistance. Wall Street analysts update their earnings estimates only occasionally, but one way to track real-time changes in profit expectations is by calculating earnings implied by stock prices and the market’s long-term average earnings multiple.
For example, the S&P 500 Index has traded at an average of 18 times forward earnings since 1990. If you had applied that long-term average multiple to the index’s peak of 6,144 on Feb. 19, it would have implied earnings of $341 a share. That was just a tad higher than analysts’ mean forward three-year earnings estimate of $334 a share. Since then, the S&P 500 has tumbled to 5,572, implying forward three-year earnings of $310 a share, or a 9% decline. The haircut echoes the warning from Treasury markets.
And finally, I look at inflation expectations. If there’s a silver lining in a slowing economy, it should be lower inflation, and that’s the scenario markets appear to be contemplating. The five-year breakeven — the difference in yield between nominal and inflation-protected five-year Treasuries — has declined modestly to 2.5 percentage points since mid-February, meaning that it projects inflation of 2.5% annually over the next five years. The alternative is stagflation, a dreaded combination of slowing growth and higher inflation, which can’t be ruled out given the uncertainty around tariffs and their potential impact on prices.
On balance, markets seem to be signaling that the economy is slowing modestly, contrary to the deep recession or even crisis many fear. It’s a remarkably measured signal amidst the noise swirling around the White House. A deep recession or crisis would normally involve some combination of aggressive Fed rate cuts, rising bond defaults and sharply lower corporate earnings preceded by a rally in Treasuries, surging credit spreads and a bear market in stocks. This is not that.
For now, look for a softer job market, stable inflation, moderately lower mortgage rates and a less ebullient stock market. But stay tuned — whatever happens, markets are likely to know about it first.
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