Investors are skating on dangerously thin ice as cracks grow louder

US markets

A Canary in the coal mine? The US consumer is finally feeling the pinch

U.S. stocks took a beating on Friday, with the S&P 500 tumbling 1.7%—its worst slide since December 18. The sell-off came amid a wave of disappointing economic data, showing that sentiment among consumers and businesses has cooled just one month into Donald Trump’s presidency.

The tech-heavy Nasdaq Composite fell even harder, down 2.2%, marking its steepest drop since January 27, when worries over Chinese AI upstart DeepSeek sent shockwaves through the sector.

This sudden equity downturn starkly interrupted a relentless stock market rally. Just days earlier, the S&P 500 hit fresh all-time highs. But now, the economic cracks are showing, and investors are noticing.

The selloff coincided with a series of data releases that painted a much darker picture of the U.S. economy. The key takeaway? The U.S. consumer—the so-called "bastion of resistance"—is finally under strain. With the services sector accounting for more than 75% of U.S. GDP, any softening in consumer spending is a flashing red warning sign.

The biggest shocker was the January retail sales report. Inflation-adjusted retail sales plunged at a staggering 15% annualized rate, marking the most significant downside surprise yet. Higher-income households have kept the economy afloat for months, buoyed by the rising wealth effect. Meanwhile, lower-income consumers have been squeezed by soaring credit card rates and relentless price increases in services, food, energy, and housing.

But now, even high-income earners are tightening their purse strings, and Walmart’s latest earnings warning is a clear signal. Last Thursday, the retail giant cut its sales and profit growth outlook, sending its stock down 6.5%. If higher-income households start pulling back more aggressively in 2025, the outsized spending gains that kept the U.S. economy humming in late 2024 could evaporate. The market’s read-through is crystal clear—investors are skating on dangerously thin ice, and the cracks are getting louder.

Perhaps even more concerning is how quickly "stagflation" has re-entered the market lexicon. While some weakness could be chalked up to seasonal factors—cold weather, snowstorms, or even temporary consumer fatigue—traders won’t wait for clarity. If stagflation becomes even slightly entrenched in the narrative, expect traders to wallop the sell button—not just on stocks, but on bonds too—injecting even more volatility into FX markets.

The question remains: Is this just a short-term economic soft patch or the start of a more prolonged slowdown? The Fed and markets are in for a reality check if it's the latter.

For now, the biggest inflation risk on the market’s radar isn’t wage growth or supply chain bottlenecks—it’s import tariffs. With baseline inflation forecasts creeping higher, many expect core PCE inflation to remain stuck well above the Fed’s 2.0% target through the end of the year—and possibly beyond.

As we move into the tail end of the month, traders already know what’s coming—PCE inflation day. The Federal Reserve’s preferred inflation gauge is expected to show its slowest pace since June, but let’s not pretend inflation is under control. The road to disinflation has been excruciatingly slow, and tariffs could make it even worse.

The core personal consumption expenditures (PCE) price index, which excludes volatile food and energy prices, is projected to have risen 2.6% year over year in January. While that may seem like a step in the right direction, there’s a real chance this is as good as it gets for 2025. With new tariffs rolling out, the risk is that inflation will remain sticky, persistent, and far too high for the Fed’s comfort.

While headline PCE inflation is expected to ease slightly, the glacial pace of disinflation will keep the Fed firmly in wait-and-see mode. The central bank has made it abundantly clear: they want sustained, decisive progress before cutting rates. A slight decline in inflation won’t be enough to move the needle—especially if tariff-driven price pressures start creeping into the data later in the year.

At this point, the market needs more than a lukewarm print—it desperately needs a meaningful downside surprise to offset some of the inflationary panic tied to tariffs. The key will not be the number itself but the market’s reaction.

But if PCE surprises to the upside? Brace for impact.

A hot print would spark a massive hawkish repricing, pushing rate-cut bets further down the road. Stocks would tank, yields would rise, and the dollar would surge. In short, all risk assets would take a hit.

This is the market’s next big test. Either inflation starts cooling more decisively, or the Fed will have no choice but to sit tight—and that’s the last thing equity bulls want to hear.

Asia markets

Asian markets set to open in damage control mode after Wall Street’s Friday wipeout

Asian stocks are heading into Monday, picking up the shattered remains of Wall Street’s Friday selloff. With U.S. stagflation fears gaining momentum and Trump’s latest tariff threats throwing another wrench into global trade dynamics, risk sentiment looks fragile at best—radioactive at worst.

The selloff in U.S. equities wasn’t just a pullback but a wake-up call. Investors have been riding the U.S. consumer bull narrative for months. Still, the ugly US retail sales data, cooling sentiment indicators, and sticky inflation signals suggest the economy may not be as invincible as markets once thought. Add Trump’s renewed trade war drumbeat, and you have a recipe for full-blown uncertainty heading into the new trading week.

Expect Asian markets to react in kind, with currency traders laser-focused on JPY and CNH as barometers for risk appetite and capital flows. If Wall Street’s slide wasn’t just an end-of-week shakeout but the start of a broader de-risking trend, Asia could be in for a bumpy session.

European markets

German election tail risk averted

Germany’s most high-stakes election in years has set the stage for a significant shift in fiscal policy. Market participants are already discussing the possibility of increased spending under the new leadership, and some will position themselves for this. If the early reading is correct, the era of constrained fiscal policy may be nearing its end.

The euro inched slightly higher during the early open, often called the "grey zone" due to its notorious lack of liquidity. This move came in reaction to exit polls and early vote projections, which confirmed expectations that the conservative CDU/CSU bloc, led by Friedrich Merz, secured victory in Sunday’s election. Bond and stock futures will begin trading at 1 a.m. in Berlin, but for now, the key takeaway is that the results didn’t diverge significantly from polling data, avoiding any market shock.

From a risk sentiment perspective, the outcome is viewed as moderately favourable—primarily because Germany has dodged the extremist political tail risk that could have rattled investors. Market speculation is already mounting that Merz will take a more pro-business, pro-investment stance, easing Germany’s rigid debt brake to stimulate growth.

That said, even as German leaders realize that their economy needs a serious boost, this will not immediately help the struggling German economy. It’s a multi-year exercise, not a quick fix.

Further complicating matters, Europe urgently needs to ramp up defence spending as the U.S. scales back its security commitments to the region. If increased government spending is offset by austerity elsewhere, the market could see the opposite of the intended economic boost.

For now, the market’s response suggests that investors are cautiously optimistic—but the real test will come in the next few months as the coalition government forms and fiscal priorities start to take shape.