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Video: CIO's Thomas Wacker on whether US fiscal policy is at a breaking point (8:03)

Comments from President Trump that the trade conflict with China was "done" and softer-than-expected inflation readings supported investor sentiment early in the day on Wednesday, pushing the S&P 500 closer to its all-time high in February and sending Treasury yields lower.

However, US stocks ended the day lower. Despite the positive rhetoric, President Trump and Chinese leader Xi Jinping have yet to officially sign off on the framework agreed in London earlier this week. Trump also later said he intended to send letters to trading partners in the next one to two weeks setting unilateral tariff rates. And the media reported that US personnel were being moved out of the Middle East amid heightened security risks. US equity futures are down 0.6% and gold is up 1% ahead of the US open on Thursday.

With the S&P 500 having rebounded more than 20% over the past two months, we think much of the trade optimism has been priced in for the near term. But uncertainty remains around Federal Reserve policy, the US fiscal outlook, geopolitical conflicts, and ongoing trade negotiations.

Fed rate cuts could be delayed if labor market resilience continues. US consumer price inflation in May came out softer than expected, with both the headline and core measures of the Consumer Price Index (CPI) rising 0.1% month over month. Core services inflation, which excludes energy prices, continues to trend lower, helped by moderating shelter inflation. But we expect to see more noticeable price increases in the months ahead as inventories built before the new tariffs hit are used up and more of the cost is passed through into retail prices. While our base case is for the Fed to resume policy easing in September, our view remains that the US central bank will need to see weaker labor market data in order to do so. This means that further interest rate cuts could be delayed if payroll growth remains solid while tariffs are pushing up inflation.

Additionally, Treasury yield volatility remains a focus amid fiscal deficit worries. While the USD 39bn sale of 10-year debt on Wednesday went smoothly with solid demand, investors are likely watching today’s USD 22bn auction of the 30-year bonds closely to gauge investor appetite.

Geopolitical conflicts are far from being resolved. The US State Department said on Wednesday it has ordered the departure of non-emergency US government personnel in the Middle East due to heightened regional tensions, with Trump saying the region “could be a dangerous place.” No details of specific security risks were provided, but Trump reportedly said in an interview that he was growing less confident that Iran would agree to stop enriching uranium. Trump has repeatedly threatened to strike Iran, while Iran said it would retaliate by hitting US bases in the region. Separately, Israeli strikes in Gaza continue, with no breakthrough expected in ceasefire talks between Israel and Hamas this week. The European Union this week proposed an 18th round of sanctions against Russia over its war in Ukraine.

The path to lasting trade deals is likely to be bumpy. The London agreement to restore the US-China trade truce is positive. But the Wall Street Journal reported that China is putting a six-month limit on the relaxation of rare earth exports, while shipments of the most advanced AI chips from the US are still likely to be subject to restrictions. This suggests that both countries retain the tools to quickly escalate tensions again. While US Commerce Secretary Howard Lutnick said “deal after deal” with other countries will follow in the weeks ahead, we continue to expect further twists and turns in trade negotiations. Legal uncertainty will also remain high, as court challenges over Trump’s unilateral use of the International Emergency Economic Powers Act (IEEPA) to impose tariffs remain in progress.

So, while we expect US equities to move higher over the next 12 months, near-term volatility should be expected. We think phasing into equities can be an effective way to overcome the challenges of market timing, while structured strategies can help manage volatility. Investors should also hold sufficient exposure to medium-duration quality bonds, gold, and alternatives like hedge funds to enhance portfolio resilience.