Inflation

The inflation picture entering this week is defined by two conflicting forces: the disinflation process has stalled, yet the deflationary impulse from a tariff resolution is simultaneously emerging. December core PCE registered 3.0% year-over-year, accelerating modestly from prior months and firmly above the Fed's 2% target. Headline PCE also came in above expectations. The composition of the print remains problematic: services inflation, particularly shelter and healthcare, continues to demonstrate the persistence the Fed has warned about for over a year. Goods deflation, once a powerful disinflationary offset, is fading as the tariff-distorted supply chain environment stabilizes — or in this case, becomes newly unstable under a fresh 15% global tariff structure. Average hourly earnings have moderated from their post-pandemic peaks but continue tracking above levels consistent with 2% inflation on a sustained basis.

The Fed's response has been to hold rates steady at 3.50-3.75% while the committee works through conflicting data signals. FOMC minutes from the January meeting revealed notable internal disagreement: two dissenting governors — Christopher Waller and Stephen Miran — called for immediate rate reductions, citing labor market fragility concerns, while a separate faction within the committee flagged that inflation persistence could warrant consideration of further hikes. This is not a committee with a unified policy view. Markets, processing this division alongside sticky PCE and a weak GDP print, are currently pricing in approximately two 25-basis-point cuts in 2026, with the first cut's timing shifting from March toward June following the core durables orders beat of 0.9% reported February 18th.

The Supreme Court's tariff ruling introduces a genuine two-sided inflation scenario that the Fed cannot currently handicap with confidence. On one hand, the potential unwinding of IEEPA-based tariffs — with up to $175 billion in refunds possible according to the Penn Wharton Budget Model — could represent a deflationary shock to goods prices. On the other hand, Trump's swift replacement with a 15% global baseline tariff preserves and potentially intensifies the inflationary pressure on imported goods. Until the legal durability and enforcement scope of the new executive tariff structure becomes clear, the Fed's forward guidance will remain deliberately ambiguous. Core inflation is not cooperating with a dovish pivot, and the committee knows it.

Risk and Positioning

Friday's session was technically risk-on — VIX fell 5.64% to 19.09, equities gained broadly, and the Nasdaq snapped a five-week losing streak — but the character of the rally demands scrutiny. The initial Supreme Court ruling triggered the expected relief trade, with Amazon and Home Depot leading as markets priced in potential tariff refunds. Yet by the session's end, equities had navigated a volatile intraday reversal, recovering losses after Trump announced the 10% executive replacement tariff. That the market could digest a new global tariff within the same session and still close up 0.69% speaks more to positioning-driven buying than fundamental conviction. With futures already down 0.5% pre-open Monday following the 15% tariff escalation, the relief rally's staying power is already being tested.

Positioning metrics reflect a market that has been gradually repricing risk since the January 27th all-time high of approximately 7,002 on the SPX. The index has spent ten consecutive sessions below its 50-day moving average while remaining comfortably above the 200-day, a classic warning zone where momentum has deteriorated without yet triggering a structural breakdown. The Russell 2000 closed down 0.05% Friday and flat to negative on the week, confirming that small-caps — the most domestically exposed and tariff-sensitive cohort — are not participating in any tariff-relief narrative. The S&P is approximately 1.3% off its all-time high, but breadth tells a more cautious story: with narrow mega-cap leadership concentrated in Alphabet and a handful of AI-adjacent names, the underlying participation remains fragile.

Credit markets are providing a cleaner read on risk appetite: investment-grade and high-yield spreads have widened modestly in recent weeks as economic growth concerns mounted alongside the tariff uncertainty overhang. Gold is executing a textbook safe-haven move — up 1-2% in futures Monday morning, near multi-year highs in the $5,100-5,200 range — as the combination of policy uncertainty, geopolitical tension around Iran, and dollar weakness is attracting defensive capital. The dollar's 8.56% year-over-year decline, with DXY sitting near 97.79 and testing support at 96.00-96.50, reflects a broader erosion of confidence in U.S. policy predictability that institutional investors cannot ignore. The simultaneous strength in gold and weakness in the dollar is a classic "sell America" positioning signal that bears monitoring if it intensifies.

Sector and Cross-Asset Analysis

Friday's sector leadership was concentrated in technology and communication services, with Alphabet surging 3.7% as the primary index driver. Amazon gained 2.6% on tariff-refund optimism, as the company would stand to benefit materially from any return of IEEPA-collected duties. The Nasdaq Composite's 0.90% gain versus the S&P's 0.69% and the Dow's 0.47% confirms that this remains a large-cap technology-led market. The equal-weight S&P 500 (RSP) has meaningfully underperformed the cap-weighted index year-to-date, signaling that the rally is narrow rather than broad — a condition historically associated with elevated vulnerability to single-factor disruptions. Small-caps (Russell 2000, -0.05% Friday, up only modestly on the week) have diverged from the cap-weighted index in a manner that would concern anyone extrapolating broad economic strength from index-level performance.

Cross-asset dynamics on Friday reflected a transitional moment: equities up, VIX down, dollar flat, and yields barely moved (+1bp on the 10-year to 4.08%). This is not a coherent risk-on signal — it is a market in price discovery following a seismic legal event. The 2s10s spread (10-year minus 2-year yield) now sits at a positively-sloped 60 basis points, with the 2-year at 3.48% and the 10-year at 4.08%, representing the most normalized curve shape since before the 2022-2023 inversion cycle. A positively sloping curve is consistent with a late-cycle or transitional regime where markets are pricing a return to economic growth, but the quality of that growth forecast is increasingly questionable given the GDP miss and tariff fog. The long end of the curve at 4.72% (30-year) is reflecting some residual inflation premium that the front end does not yet fully price.

European equities outperformed on Friday — the DAX gained 0.87%, CAC +1.39%, and Euro Stoxx 50 +1.18% — as continental markets priced in relief from potential tariff removal more aggressively than U.S. markets did. That optimism has already been partially unwound given Trump's 15% Saturday escalation and EU Commission statements expressing concern over the new structure. International divergence — with European and Asian equity markets at times moving inversely to U.S. policy signals — is becoming a defining feature of 2026 cross-asset dynamics. Gold's move above $5,100 and silver's 4%+ surge on Monday morning underscore a broader rotation into hard assets and away from dollar-denominated paper assets that sophisticated institutional investors are accelerating.

Economic Data & Events

Today's Calendar

• All Day MT — Manufacturers' Shipments, Inventories & Orders Full Report (M3, December data) — Moderate Impact