Weekly Investment Perspective

Markets opened the year with a steady hand despite an increasingly complex policy and geopolitical backdrop that has continued to build with meaningful longer-term implications, even as markets showed limited near-term disruption. The Dow Jones Industrial Average and S&P 500 notched fresh record closes by week’s end with gains of 2.3% and 1.6%, respectively, even as Big Tech lost a bit of leadership and cyclicals took the baton. Market breadth improved notably, with equal-weight indexes outperforming their cap-weighted counterparts and investors leaning into banks, homebuilders, industrials, and precious-metals miners. Mid- and small-cap stocks benefited the most from the rotation into more economically sensitive assets with the S&P Midcap 400 and S&P SmallCap 600 rising 3.3% and 4.1%, respectively.

That calm is being tested in this week’s early trading following weekend developments that have raised fresh concerns around the independence of the Federal Reserve. Over the weekend, the Fed disclosed it had been served subpoenas from the Justice Department related to prior congressional testimony over headquarters renovation costs. In a rare video message released Sunday, Chair Jerome Powell warned that “the threat of criminal prosecution is being used as a means to influence monetary policy decisions,” linking the episode to broader political pressure on the central bank. While Powell struck a measured tone and emphasized the Fed’s commitment to its mandate, the situation underscores the importance of institutional independence at a time when policy decisions remain finely balanced. Early market reaction has been cautious, with interest rates ticking modestly higher and U.S. equities under pressure.

Federal Reserve independence now sits squarely at the center of the macro conversation. Markets have long taken confidence in the Fed’s ability to pursue its dual mandate free from political influence, anchoring inflation expectations and supporting financial stability. While we do not view this episode as an immediate threat to policy operations, sustained political pressure would introduce a new source of volatility and complicate the path ahead as the Fed weighs cooling labor markets against still-elevated inflation and fiscal deficits.

The labor picture kept the “no‑hire, no‑fire” narrative intact. December nonfarm payrolls rose by 50,000, shy of expectations, but the unemployment rate dipped to 4.4%. Wages grew a manageable 0.3% m/m (3.8% y/y), consistent with a disinflationary glide path rather than a wage‑price spiral. The mixed message—soft hiring, steadier jobless rate—reinforced the view that the Fed can stay on hold near‑term while it assesses momentum.

High-frequency reads echoed that balanced backdrop. ISM services jumped to 54.4, its highest since late 2024, with new orders at 57.9 and employment back in expansion—a sign that service-sector demand is still doing the heavy lifting. Meanwhile, ISM manufacturing remained in contraction, a reminder that 2025 was a difficult year for factories and that any industrial recovery is likely to be gradual rather than abrupt.

On the consumer side, sentiment ticked up for a second month to 54.0—not strong historically, but an improvement from the fall swoon. Year-ahead inflation expectations held at 4.2%, while concerns around tariffs appear to be fading modestly at the margin. The takeaway remains that households are focused on day-to-day affordability, but equity market gains continue to support spending among higher-income cohorts.

Oil added a modest tailwind to cyclicals. WTI advanced for a second straight week, hovering around $59 as markets weighed Venezuela-related headlines against still-ample global supply. While the move was not large enough to materially alter the inflation outlook, it supported energy and refining stocks. More broadly, energy markets continue to serve as the key transmission channel through which geopolitical risk could re-enter the inflation and growth narrative, even if recent episodes have been met with muted price responses.

Policy risk remained noisy, but importantly, markets mostly looked through it. The Supreme Court did not issue the anticipated ruling on tariff authority under the IEEPA, leaving trade policy in limbo for now. Expectations continue to favor a hold at the upcoming Fed meeting alongside a watch-and-wait approach on tariffs, reinforcing the broader theme that markets are discounting policy uncertainty until it begins to materially impact growth or inflation.

This remains a bifurcated economy—services steady, goods soft; hiring cautious, layoffs low; confidence subdued, wealth effects intact. Looking ahead, next week brings December CPI, PPI, retail sales, and the kickoff to bank earnings, all of which will help shape expectations around rates, earnings durability, and leadership within equities. While policy-driven volatility has the potential to resurface, underlying economic fundamentals continue to provide a stabilizing force as the year begins.

2025 The Long View | First Merchants Bank