Analysis-US stock market confronts risks as investors grapple with tech, Fed outlook

By Saqib Iqbal Ahmed, Suzanne McGee and Lewis Krauskopf

NEW YORK (Reuters) - Risks to the U.S. stock market are piling up as cracks emerge in the technology trade and the path for interest rates is clouded by persistent inflation worries that are being exacerbated by the potential for looming tariffs.

Mixed results from megacap companies Microsoft (MSFT), Tesla and Meta Platforms (META) on Wednesday threatened to add to volatility following ruptures earlier in the week in the artificial intelligence trade that has helped propel tech's stock market leadership.

The Federal Reserve also paused its rate-cutting cycle on Wednesday -- a decision that investors had been bracing for. Prospects for when the U.S. central bank could resume easing remained in doubt amid expectations President Donald Trump will enact trade and other policies that stand to be inflationary.

"Everything that is going on right now, from economic data to markets news and tariffs, adds up to a lot more uncertainty across all markets," said Dustin Reid, chief strategist of fixed income at Mackenzie Investments in Toronto.

"We are putting less risk on the table; cutting position sizes, because we don't want to have as much risk as we would have had otherwise."

In its first meeting of 2025, the Fed kept its benchmark rate at 4.25%-4.50%, after reducing the rate by a full percentage point last year. The annual pace of inflation has stayed above the central bank's 2% target, and Fed Chair Jerome Powell said there would be no rush to cut rates again until inflation and jobs data made it appropriate.

"A pause in policy rates is likely to be with us for a number of months as more data comes in," Rick Rieder, BlackRock's chief investment officer of global fixed income, said in written commentary.

Markets kept intact expectations for roughly two more interest rate cuts this year. The S&P 500 closed down 0.5%, while the benchmark 10-year Treasury yield edged lower to 4.53%.

Uncertainty over the Trump administration's policies continues to keep investors on edge.

Trump has set a Saturday deadline for imposing 25% tariffs on goods from Canada and Mexico, two of the largest U.S. trading partners.

While these tariffs may be a negotiating tool, the administration's general willingness to impose them on foreign imports remains a risk that could revive inflation and cloud the outlook for rate cuts and the broader economy

Powell said it was too soon to say what Trump's policies will do, but that "we are going to be watching carefully" what is being put in place.

"The reality is that the Fed is simply trying to respond to the data and the new administration's policies as they unfold," Seema Shah, chief global strategist at Principal Asset Management, said in written comments. "At times like these, when government policy -- particularly tariff policy -- is so uncertain, they do not have a forecasting edge."

While the benchmark S&P 500 is near record highs, the rally wobbled this week. News of a low-cost Chinese artificial intelligence model called DeepSeek sent shockwaves through a broad swath of high-flying technology stocks that had benefited from the business potential of AI.

"We have been saying this for several months ... you need to diversify, not just across asset classes but within equities too," said Sonu Varghese, global macro strategist at Carson Group.

"What happened on Monday underlined it," Varghese said.

Even with the recent volatility in stocks, the market's valuation remains historically high. The S&P 500 is trading at about 22 times earnings estimates for the next 12 months, well above the long-term average P/E ratio of 15.8, according to LSEG Datastream.

Strength in tech shares has been the key driver of the bull stock market, giving an advantage to U.S. equities over their global counterparts. Confidence in the tech trade, however, was being tested.

Investors digested results from Microsoft (MSFT), Facebook parent Meta and Tesla -- three of the Magnificent Seven megacap stocks whose combined gains accounted for over half the S&P 500's 62% return since the end of 2022, as of Monday.

Microsoft (MSFT) reported slower-than-expected growth in its crucial Azure cloud business. Meta's revenue beat Wall Street expectations but the company predicted sales in the current quarter may not meet forecasts. Tesla said it was on track to roll out cheaper electric vehicle models in the first half of 2025, as its quarterly results missed estimates.

Following Monday's AI developments, the big moves in some tech stocks showed "that people do have their finger on the sell button," said Mark Hackett, chief market strategist at Nationwide.

"The buy the dip mentality is still there," Hackett said. "It's just that we've gone from a glass half full mindset on some of these names to a little bit more balance and perhaps even a little glass half empty."

(Reporting by Saqib Iqbal Ahmed, Suzanne McGee and Lewis Krauskopf; editing by Diane Craft)