Week of 5/12/25: Markets Rally on Tariff Reprieve But Risks Linger

• Earnings and consumer data were mostly weak. 

• Equity markets rallied on a temporary US - China tariff truce.

• Credit markets tightened although economic fundamentals are softening.

Tariff Moratorium Fuels Risk-On Sentiment: Equity and leveraged credit markets were risk-on this week, driven by a temporary reprieve in U.S.-China tariff tensions. Both nations agreed to a 90-day moratorium on imposing significant new tariffs - 30% (from 145%) for Chinese goods and 10% (versus 125% on American products). A disruption in trade would have meant empty shelves and idle warehouses, a potentially disastrous scenario that appears to have been narrowly avoided. While the agreement is temporary, markets appear to be assuming a permanent truce. Additionally, despite all the debt ceiling related headlines, US Treasuries demand from foreign buyers remained solid. 

Earnings Season Highlights Mixed Consumer Trends: Earnings continued to roll in this week, including from companies in retail, advertising, consumer discretionary, automotive, and electronics. Notable names like Clorox, Wendy’s, Warner Bros, Hertz, and Deere either missed expectations or issued weaker—or withdrawn—forward guidance. This is just a continuation of a theme observed over the past few weeks. This potentially, allows management teams to beat earnings if the US avoids a recession and trade stabilizes.

Inflation and Retail Sales Show Softer Economic Activity: The Consumer Price Index (CPI) rose just 0.2% month-over-month, versus expectations of 0.3%, and came in at 2.8% year-over-year. The softer inflation print gave equity markets a further boost, as traders began speculating on future rate cuts. However, this is premature as both CPI and Personal Consumption Expenditure (PCE) will be distorted with consumers and businesses managing through the transitory period of on again and off again trade war and resulting pre-buying. 

Retail sales rose just 0.1% compared to 1.4% last month. The “control group,” which excludes volatile categories and feeds into GDP calculations, declined 0.2% versus a 0.4% gain previously. This will be a headwind for GDP, though swift changes in policy and sentiment could still lead to a rebound in consumer spending.

The 10-year Treasury yield briefly touched 4.5% this week, helping push mortgage rates to a recent high of 6.8%. Housing affordability continues to be challenged, and that pressure is starting to show: the NAHB homebuilder sentiment index dropped to 34 in May, down sharply from 40 in April.

Leveraged Credit Markets Rebound: The leveraged loan index climbed back to 96.6, recovering to pre-Liberation Day levels. New issuance picked up this week, with accelerated timelines, drive-by deals, and several reverse-flexes.

High yield bonds also saw a rally, with YTW compressing to 7.5%, down from 8.7% in early April. 

CLO markets (the largest buyers of leveraged loans) are responding in kind. AAA-rated secondary U.S. CLO spreads have tightened to 136 bps from 150 bps just weeks ago, and several banks forecast further spread compression for CLO liabilities. In theory, this would raise equity IRRs and spur additional CLO formation, which could then further compress underlying loan spreads. Spread compression may plateau if the new issuances to fund M&A picks up. We are seeing some evidence of that, which will boost CLO arbitrage. 

Ironically, all this is happening against a backdrop of deteriorating U.S. corporate fundamentals—weak earnings, cautious guidance, and signs of strain in consumer-linked sectors.

Conclusion: There is renewed optimism in both equity and credit markets. This is hinging on the “temporary” trade truce between US and China, although underlying fundamentals point to late cycle behavior by consumers and businesses. I think valuations are rich and fundamental investors will be rewarded for doing deeper bottoms up work. 

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