U.S. Equities Near Record Highs: Can the Rally Hold Amid Fed Rate Cut Speculation and Trade De-escalation?

The S&P 500 (^GSPC) has surged to within striking distance of its February 2025 peak of 6,144.15, driven by mounting expectations of Federal Reserve rate cuts and a tentative thaw in U.S.-China trade tensions. As of June 19, the index closed at 5,675.29 but rebounded to 6,141.02 by June 26, underscoring the market's optimism. Yet, with the Fed's policy path and trade negotiations still clouded by uncertainty, investors face a critical question: Is this rally sustainable, and which sectors stand to gain the most?

Body 1: Fed's Messaging vs. Market Pricing—A Growing Divide

The Federal Reserve's latest dot plot, released in June 2025, revealed a cautious median outlook of two 25-basis-point rate cuts by year-end, leaving the federal funds rate at 4.00%–4.25%. However, seven of 18 FOMC members signaled no cuts in 2025 at all, reflecting hawkish concerns about persistent inflation. Meanwhile, markets have priced in a 65% probability of at least one cut by September 2025, with the CME FedWatch Tool forecasting a 32.1% chance of a December rate cut bringing the Fed funds rate to 3.75%–4.00%.

The disconnect between the Fed's gradualism and market optimism stems from differing inflation outlooks. The Fed remains fixated on “sticky” core inflation (projected at 3.1% in 2025) and the risk of new tariffs reigniting price pressures. Chair Jerome Powell reiterated this stance in a June speech: “We will not cut rates until we see durable evidence of inflation moving toward 2%.” In contrast, markets are pricing in a “soft landing” where slowing GDP growth (now forecast at 1.4% for 2025) and easing wage pressures will force the Fed's hand.

Body 2: Trade Tensions—A Fragile Catalyst for Sector Gains

The U.S.-China tariff truce, agreed in May 2025, temporarily reduced reciprocal tariffs to 10%, but its expiration on July 9 looms as a critical risk. If extended, sectors exposed to trade flows—industrials, tech, and materials—could see significant tailwinds. For instance:
- Industrial stocks (e.g., Caterpillar CAT, Boeing BA): Lower tariffs on machinery and components could boost margins.
- Semiconductors (e.g., NVIDIA NVDA, Texas Instruments TXN): Reduced trade barriers could ease supply chain bottlenecks.
- Materials (e.g., Freeport-McMoRan FCX): A de-escalation could stabilize commodity prices pressured by Section 232 tariffs on steel and aluminum.

However, the truce's fragility is underscored by ongoing non-tariff barriers. China's export controls on critical minerals and U.S. tech export restrictions remain unresolved. Analysts at Bank of America warn: “A failure to extend the tariff rollback could send the S&P 500 tumbling 5%–10%, with industrials and tech bearing the brunt.”

Body 3: Valuations and Technicals—Fundamentals vs. Overheating

Despite the rally, valuation concerns linger. The S&P 500's trailing P/E ratio of 21.5 is above its 15-year average of 18.7, with tech and consumer discretionary sectors trading at premiums. Meanwhile, cyclicals like industrials (P/E ~15.3) and materials (P/E ~10.4) remain relatively undervalued.

Technical resistance at the February peak (6,144.15) is a key hurdle. If breached, momentum could push the index toward 6,300. However, a failed breakout could trigger profit-taking. Strategist Michael Hartnett of Bank of America notes: “This rally is heavily dependent on Fed easing and trade optimism. Without tangible progress on both fronts, we could see a summer correction.”

Conclusion: Positioning for a Fed-Driven Cycle, with Caveats

Investors should overweight cyclical sectors if the Fed delivers cuts and trade talks succeed. Consider:
- Industrial ETFs: The Industrial Select Sector SPDR Fund (XLI) offers exposure to tariff-sensitive names like Boeing and Caterpillar.
- Tech ETFs: The Technology Select Sector SPDR Fund (XLK) could benefit from reduced trade friction and lower borrowing costs.
- Materials ETFs: The Materials Select Sector SPDR Fund (XLB) could rebound if metal tariffs are rolled back.

However, avoid overvalued defensive sectors like utilities (XLU) or Treasuries if the Fed remains hawkish. Additionally, hedge against trade risks by allocating to commodities (e.g., gold via GLD) or inflation-protected bonds (TIPS).

The path forward hinges on two variables: Fed policy discipline and trade deal durability. Until both are confirmed, the rally remains a “wait-and-see” story—position cautiously, but stay nimble.

Actionable Takeaway:
- Buy XLI (XLI) if the S&P 500 closes above 6,144.15.
- Avoid XLU (utilities) unless the Fed signals a 2026 pivot.
- Monitor the July 9 tariff deadline for trade ETF rotations.