Markets Reprice Risk as Fed Signals Caution and Breadth Broadens

Executive Summary  

The S&P 500 returned +0.3% for the week, recovering from a mid-week wobble. The Fed held interest rates steady and signaled no rush to lower rates amid a strong economy, while tech stocks fell with a weak outlook from Microsoft with investors questioning the timeframe for returns on its AI-related spending. However, markets looked favorably upon President Trump’s nomination of Kevin Warsh as the next Fed Chair, sending the dollar higher and commodities and precious metals lower; gold saw its largest drop in four decades while silver plunged 26%. Mid cap (-1.2%) and small cap (-2.1%) stocks underperformed large caps. Communication services (+4.2%) and energy (+3.9%) were the best performing sectors in the S&P 500; healthcare (-1.7%) and consumer discretionary (-1.4%) were the laggards. EAFE markets returned +1.6% with gains across geographies, while EM markets returned +1.8% led and Korea (+8.0%) and recovery in India (+1.3%).  

From a valuation perspective, the S&P 500, NASDAQ, EAFE and EM trade at or above +1 standard deviation based on historical forward P/E ratios with the S&P 500 at +1.8, NASDAQ at +1.1, EAFE at +1.5 and EM at +1.4. For the next 12 months, EPS growth for S&P 500 is expected to be 12.3% (vs. 6.9% annualized over the last 20 years). For the next 12 months, EPS growth for NASDAQ is expected to be 26.3% (vs. 10.7% annualized over the last 20 years). Equities across markets caps in the U.S., and in non-U.S. developed and emerging markets, trade at or above their 20-year averages based on forward P/E ratios.   

The Fed Announcement and Markets  

The Fed composition now hinges on two questions. One, how quickly can Warsh be confirmed? The timing remains uncertain because Senator Tillis has pledged to block all nominations until the legal matter around Powell is resolved. Two, if Warsh replaces Mirren or will Powell step down? A likely scenario, we believe, is that charges are dropped and Warsh will replace Powell in May.  Warsh has been considered more of a hawk, especially when it comes to believing in limited use of the Fed balance sheet. But more recently, he expressed that rates can be cut. He sees AI-driven productivity gains as deflationary and tariffs as largely one-off distortions to inflation.   

The response to Warsh’s nomination in the equity markets, fixed income markets and the dollar overall was contained. However, the reaction of precious metals was magnitudes more severe than for other asset classes.  Gold declined by ~10% and silver fell even more sharply by ~ 25%. Prices for both gold and silver have risen exponentially since President Trump came into power. And despite last Friday's decline, prices for both are still up on the year. This episode illustrates that markets are most vulnerable when capital inflows have been most excessive. In these situations, one announcement can have an outsized impact. Gold in particular has become a way to express the dollar debasement fear. The gold demand themes have been a structural bid of central bank buying, potential loosening of monetary policy, and geopolitics.   

Breadth in Equity Markets 

We are already seeing this breadth in the pattern of returns. As the domination of global equity markets by a small group of mega-cap growth and AI-related stocks fades for now, smaller companies, value sectors and non-U.S. markets have begun to show meaningful outperformance versus large-cap U.S. indices over recent months, and the gap in returns year-to-date is noticeable.  

The Russell 2000 Index of small-cap stocks is, for instance, up 5.4% in January 2026 and 1.4% for the S&P 500 Index. What’s more, the MSCI ACWI ex-U.S. Index is up 5.7% and the MSCI Emerging Markets Index has gained 7.7% in the same period, representing a month of positive outperformance, especially versus most of the “Magnificent 7” stocks.  

Clearly a shift is under way, from a market priced around a handful of names to one where more sectors, styles and regions are contributing meaningfully to equity returns.  

Fixed Income  

Investment grade fixed income sectors had mixed returns as rates rose slightly at the long end of the curve. Municipals returned +0.3%, US AGG returned +0.0% and US IG returned -0.1%. HY bonds returned -0.2% as spreads widened 9bps while bank loans returned -0.7%. EM debt returned +0.3% even as the U.S. dollar fell 0.6% with the spread compressing 1bp.  

Rates  

The yield curve steepened as markets digested the nomination of Kevin Warsh as the next Fed Chair. The recession-watch 3M-10Y spread widened 2bps to +57. The 2Y-10Y spread widened 8bps to +71. Rates fell in other developed markets. The BTP-Bund spread is at 0.61%. 5-year breakeven inflation expectations rose 9bps to 2.56% (vs. low of 1.88% on Sept 10, 2024); 10-year breakeven inflation expectations rose 3bps to 2.34% (vs. recent low of 2.03% on Sept 10, 2024); the 10Y real yield fell 2bps to 1.90%. For 2026, the market expects 2 cuts vs. the Fed’s guidance of 1 cut. At yearend 2025, the market expects the Fed Funds rate to be 3.13% vs. the Fed’s guidance of 3.25%-3.5%.   

Currencies/Commodities  

The dollar index fell 0.6%. The commodities complex rose 2.5% as energy prices rose 8.1% for the week. Brent prices rose 7.3% to $71/bbl amid increased geopolitical tensions and production disruption due to the winter storm in the U.S.  U.S. natural gas prices fell 17.5% after the previous week’s surge due to the snow storm while European gas prices saw fell 2.1%. Gold fell 1.9% to $4,894/oz, while Silver fell 17.5% to $85/oz and copper fell 0.4% to $592/lb.   

Market monitors  

Volatility rose for equities and for bonds (VIX = 17, MOVE = 59); the 10-year average for each is VIX=19, MOVE = 80. Market sentiment (at midweek) remained bullish, rising from +11 to +14.