A Positive Development Re Tariffs?

The stock market could be helped by tariff developments this week.  The latest news stories suggest Trump's threat of tariffs on Canada and Mexico is meant to persuade them to impose tariffs on China.  Mexico is said to have agreed to do so and could announce it on Tuesday.  It remains to be seen whether Canada will do so, as well.  Presumably, the US will not impose tariffs on them if they, in fact, follow through.  This would be a positive for stocks and fit with the historical tendency for them to move up in March, more so in April.

At the same time, the markets should continue to be concerned that the tariffs will lead to slower economic growth, if not recession, and higher inflation.  These effects may not happen immediately.  As a result, evidence to the contrary could be dismissed for being too soon to show the effects.  And, evidence that seems to support these concerns could spark a sell-off. 

From this perspective, this week's key US economic data should have little impact on the stock market if consensus estimates print.  The February Employment Report and Mfg ISM are not expected to validate the market's  fears, and thus may be discounted.  

Consensus sees a modest +133k m/m increase in Nonfarm Payrolls, not much different from the +143k in January, a  steady 4.0% Unemployment Rate, and an uptick in the Nonfarm Workweek (weather-related rebound).  Such prints would not indicate recession.  The market may focus on whether DOGE has in fact reduced Federal government jobs.  The jump in Initial Claims to an above-trend level in the latest week may have reflected these layoffs.  However, the Claims data were for a week after the Payroll survey week. Also, the week contained a holiday, which raises the possibility that seasonal adjustment may have exaggerated the increase.  The higher level of Claims needs to be confirmed in this week's release to be meaningful.

Consensus also expects a slowdown in Average Hourly Earnings (AHE) to 0.3% from 0.5% in January.  This would be good news for the inflation outlook as it would be below the prior 0.4% trend.  The market may discount a low print as not yet reflecting attempts by labor to counter the inflationary effects of the tariffs.

Consensus also looks for the February Mfg ISM to stay high, edging down to 50.8 from 50.9 in January.  The Non-Mfg ISM is expected to rise to 53.0 from 52.8.  Although still relatively low, an uptick could be important after the Market PMIs for both the US and Europe showed a sharp weakening in Service Sectors in February.  In Q424, the Mfg ISM averaged 48.1 and the Non-Mfg ISM averaged  54.1.

The Atlanta Fed model dropped its latest estimate of Q125 Real GDP to -1.5%, feeding fears of recession.  This is an early forecast based on little data, however.  In particular, the decline resulted from a large decrease in Net Exports due to a jump in imports of industrial supplies.  This jump may have been in anticipation of tariffs.  If so, much of them most likely was held in inventories.  This did not show up in January inventory data, however, but could appear in data for February or March.  There is often a timing difference between the Trade Deficit and Inventory surveys.  So, the Atlanta Fed model's estimate should probably be viewed with caution.

 

 

 

 

 

 

 

 

Sell-Off Overdone?

The stock market will face two more data points this week that will offer an opportunity to see whether it overreacted to second-tier US economic data at the end of last week.  Consensus-like prints for the Conference Board's Consumer Confidence Index and the PCE Deflator could offer relief.   But any bounce-back may be impeded by concern over the March 1 deadline for Trump's decision regarding 25% tariffs on Canada and Mexico and the April 1 deadline regarding tariffs on several major goods.   Overall, Trump's pronouncements and policies are creating a troublesome backdrop for the market.

The market will likely pay close attention to the February Conference Board's Consumer Confidence Index to see if it confirms the drop in the University of Michigan Consumer Sentiment Index.  Consensus looks for a modest decline to 102.1 from 104.1 in January, after it dropped 5 points in January.  A consensus-like print still may provide relief, as it would remain in the range seen in 2024.  The Conference Board measure is viewed as more closely related to the labor market than is the Michigan Sentiment Index.  Although government layoffs could hurt the Conference Board measure either directly by laid off workers who are surveyed or by impacting others' views of the labor market, the Unemployment Claims data don't indicate a significant deterioration in labor market conditions.

From the Fed's perspective, the most important data last week was likely the University of Michigan's 5-Year Inflation Expectations.  It jumped to 3.5%, it highest level since 1995.  It throws into doubt Powell's long-maintained contention that inflation expectations are contained.  Higher food prices and fear of tariffs were likely behind the jump.  This week, the release of the January PCE Deflator could assuage market concerns, as consensus looks for +0.3% m/m  Core.  If correct, the y/y for Core should fall to 2.6-2.7% from 2.8% in December.  The Conference Board Consumer Confidence Survey also includes 12-month inflation expectations.  It rose to 5.3% in January from 5.1% in December.

There could be some relief if Trump delays tariffs on Canada and Mexico again.  The FX market appears to believe this will be the case, as the Canadian dollar and Mexican Peso are off their recent lows.  Trump set April 1 as a possible time to announce tariffs on some goods, such as motor vehicles and pharmaceuticals.  A tariff on motor vehicles may not be necessarily bad for US auto makers.  It would allow them to raise prices, probably more than making up for the  new tariff on steel and aluminum and the tariff applied to the vehicles they make in Mexico and Canada. 

That said, Trump's topsy-turvy views of the world have increased uncertainty regarding the future.  This uncertainty could hurt current economic activity.  Besides forcing companies to rethink their supply channels (and the accompanying increased costs) to take account of possible tariffs, the potential drag on economic activity from them or a trade war could weigh on investment decisions.  The drop in the February Phil Fed Mfg Survey's measure of planned capital expenditures to its lowest level since November hints as such.  It may be too soon, however, to see a similar effect in this week's release of January Durable Goods Orders.  Consensus looks for a decent 0.4% m/m increase in Orders Ex Transportation, a larger increase than the 0.3% in December.

 

 

Macro Problems Dissipate For Now

The stock market may continue to climb this week in the absence of significant US economic data and an apparent pause in implementing tariffs.  The Fed is firmly in the background for several reasons.  Instead, the implications of the evolving macroeconomic path for monetary policy will be best seen in the ups and downs of long-term Treasury yields.  At this point, economic growth and inflation look satisfactory, once special factors are taken into account.

Fed monetary policy is on hold.  Powell and other Fed officials have made this clear, saying both policy and the economy are in a good place.  Besides these fundamental reasons for steady policy, Trump's call for lower rates stymies rate decisions in both directions.  Unless there is convincing evidence that a policy change is needed, cutting rates would raise concern that the Fed is buckling under political pressure.  Raising rates would bring on even more political pressure.  The Fed is likely to be very careful in its deliberations over the next rate move. 

Both inflation and real-side economic data for January may have been impacted by special factors, which allowed the market to discount their significance.  Although the January CPI rose more than expected, large increases in just a handful of components were responsible.  They were likely one-off start-of-year price hikes.  Bad weather across the country probably caused January Retail Sales to fall.  The part of Retail Sales that feeds into the calculation of Consumer Spending in GDP was flat relative to the Q424 average.  Sales should rebound over February and March, however, as the weather improves.  This week's January Housing Starts could be depressed temporarily by the weather, as well.  

The sustained low levels of Initial and Continuing Claims into February attest to the underlying solid performance of the economy despite the bad weather.  The strength of commodity prices also suggests US and global economic growth are doing fine.

There remains a question regarding the underlying pace of the economy and inflation once these temporary factors iron out.  The Trump Administration's cutting or disrupting government spending, both at the federal and state levels,  could exert some drag on the economy.  In addition, the plunge in illegal immigration could restrain both government spending and consumption.   As for inflation, the pass-through of the tariffs on China and steel and aluminum to consumer prices remains to be seen.  And, wage rates remain an issue, despite Powell's assertion that it is not a source of inflationary pressures.  The continuing sharp increase in food prices could spark demands for higher wages.

The tariff issue is now "in committee" as Trump directed officials to determine how to implement "reciprocal tariffs."  News reports suggest they will be difficult to implement, as many imports are made across a number of countries.  Perhaps in the end, the threat of reciprocal tariffs could be just a bargaining tool to force other countries to cut their tariffs on US exports, as has happened to some extent already with India.  In this case, reciprocal tariffs would not be a problem for the stock market.  The market, however, may turn cautious as the March 1 decision regarding Canadian/Mexican tariffs approaches.

 

 

 

 

 

Reciprocal Trade, Powell, CPI and Immigration

The stock market will be on edge this week ahead of Trump's announcement of so-called "reciprocal trade or tariffs."  Although it is not exactly clear what that means, it presumably involves connecting tariffs to tariffs or other trade barriers imposed on US exports -- potentially bad for stocks but not necessarily.  Trump says he'll hold a meeting regarding this issue Monday or Tuesday.  In contrast, the market may find relief in Fed Chair Powell's Semi-Annual Monetary Policy Testimony and key US economic data.  

Reciprocal tariffs apparently means imposing tariffs on countries to the extent they have imposed tariffs or trade restrictions on the US.  The questions for the market are /1/whether such a move would trigger a trade war, with other countries responding by raising their tariffs further?  or,  /2/ would it be used as a lever to persuade countries to remove their tariffs or restrictions on US exports?  An affirmative answer to the first question is a negative for stocks, while an affirmative for the second would be a relief and an eventual positive.  There is also a middle ground.  Trump may announce additional penalties for countries that respond by raising tariffs further, which would mitigate the risk of a trade war.  But, he also could view these new US tariffs as government-revenue-producing instruments.  The latter would suggest the tariffs will not end quickly, unlike the Mexican and Canadian 25% tariffs.  Stocks may find relief in such a middle ground, as the first possibility would lower the risk of a trade war while the second would take time to implement. 

Stocks should not find Powell's testimony problematic.  He will likely reiterate the message from the January FOMC Meeting -- growth is solid, inflation is moderating but still too high, and monetary policy is now on hold as there is a lot of uncertainty regarding fiscal policy ahead.  Powell may say the next policy move will depend on the data and not on demands by President Trump.  

Consensus looks for 0.3% m/m increases in Total and Core CPI for January.  This would not be a bad print, given the risk of start-of-year price hikes.  The Core CPI rose 0.4% in January 2024.  A 0.2% print can't be ruled out,  particularly if Owners' Equivalent Rent slows from 0.3% in December.  A consensus or sub-consensus print could allay inflation fears seen in the University of Michigan Consumer Sentiment Survey and long-term Treasury yields.

Despite Fed Chair Powell's protestation that the labor market is not a source of inflationary pressures, labor costs remain a risk to the Fed's 2% inflation target.  In Q424, Compensation/Hour -- the broadest measure of labor costs -- rose a near-trend 4.2% (q/q, saar).  It equaled the Q4/Q4 pace for 2024 and remained below the 4.8% 2023 pace.  So far so good for Powell's assertion.  However, the Q424 pace is not good for the inflation outlook if the slowdown in Productivity to 1.2% in Q424 is the new trend (was 2+%).  Then, Unit Labor Costs (ULC) would be rising around 3.0%, which is too high for the Fed to achieve its inflation target.  Whether this is a new ULC trend is too soon to say, particularly given the volatility in the measures of Compensation/Hour and Productivity.  Nonetheless, it shows that the markets still have to watch wage measures carefully.

That said, the outsized 0.5% m/m jump in January Average Hourly Earnings (AHE)  has to be viewed cautiously for three reasons.  /1/ It could have been caused by compositional shifts stemming from the month's bad weather.  /2/ There could have been one-off start-of-year hikes (AHE jumped 0.5% in January 2024, as well, followed by 0.2% in February).  /3/ Four of the thirteen major sectors had large increases that just unwound declines in December.    The two-month average of AHE is 0.4%, in line with trend.

Although consumers are concerned about the inflationary impact of tariffs, prices of imported consumer goods have not been a problem.  Excluding motor vehicles, these prices were flat over 2024, while imported motor vehicle prices rose only 2.4%.  The latter turned down a bit over the last two months of the year to boot.  The strong dollar was one reason for this favorable picture -- and the dollar will likely strengthen even more if additional tariffs are implemented.  Ironically, a stronger dollar would be an offset to "reciprocal trade" actions, making imports cheaper and exports more expensive (in foreign currency). 

The economic growth implications of the January Employment Report were mixed.  On the weak side were the slowdown in Payrolls and decline in the Nonfarm Workweek.  On the strong side was the dip in the Unemployment Rate.

The Payroll slowdown and decline in the Nonfarm Workweek could have been impacted by the month's bad weather, although BLS says it did not see any discernible weather impact in its survey.  Their soft prints resulted in Total Hours Worked in January being 0.7% (annualized) below the Q424 average.  This is a weak start to Q125, but could reverse as the bad weather effects unwind over February and March.  Such recovery would set the stage for a sizable q/q bounce in THW in Q225.  However, the slowdown in Payrolls instead could become the "new" trend, held back by labor shortages as discussed below.

The dip in the Unemployment Rate to 4.0% puts it below the 4.1% Q424 average.  This decline suggests economic growth remains above its longer-term trend.  Indeed, the Rate would have fallen by 0.2% pt were it not for upward revisions to the annual Population Controls.  

However, there is a cautionary story to tell about US population.  The 2.8 Mn in net immigration accounted for 85% of US population increase (3.3 Mn) in 2024, according to the Census Bureau.  This inflow of immigrants presumably accounted for most of the employment growth last year.  A dramatic reduction of net immigration as a result of Trump's border policy could be problematic for the Fed.  The lack of workers could be a significant constraint on economic growth.  At the same time, labor shortages could boost wage and thus price inflation.   The Fed might have to tighten to bring demand into sync with supply.

 

 

 

Tariffs Are Bad For Stocks

The stock market will likely be hurt by Trump's tariffs on Canada, Mexico and China, since tariffs have the potential to precipitate weaker economic activity and higher inflation.  However,  it may take time to see the effects, so the market may stabilize after a knee-jerk reaction as it waits to see the fall-out.  This week's key US economic data could help the market stabilize if they print near consensus.

Regarding the fall-out, negatives would be further retaliatory actions by these countries and/or anecdotal or reported price hikes.  Although shifting the locations of production may avoid tariffs, almost by definition the shifts would be to more costly places and not be market positive.  Positives would be if the three countries agree to address the fentanyl problem and thereby end the tariffs.  Also, some domestic producers could boost their profits by raising prices to match the tariffs.  

Recent history shows that tariffs and trade wars are not good for the stock market.  In Trump's first term, the stock market rally stalled for a year when he imposed tariffs and other trade barriers on China beginning January 2018.  Just like then, Trump may not be quick to undo the tariffs -- the U.S and China signed an agreement on trade in January 2020.  He may become enamored with the revenue-producing benefit for the government, helping to pay for extending his earlier tax cuts.  Doing so essentially would be substituting a "consumption tax" for an "income tax."  This substitution would have several implications.  On the plus side, a higher consumption tax increases the incentive to save.  Also, maintaining low marginal income tax rates sustains incentives to invest and work.  However, the substitution makes the government revenue machinery less "progressive," that is more a burden to lower-income than upper-income people.

The tariffs will augment Trump's anti-immigration policies in working to boost the cost of goods.   Imports are a way US consumers benefit from low-priced labor abroad without incurring the cost of bringing the workers to the US.  Tariffs serve to close this channel.  From the US labor unions' perspective, lower-priced foreign labor or increased labor supply from immigration puts downward pressure on wages.  The FX exchange rate in a perfectly competitive world should offset lower wages abroad, but the FX market is not perfectly competitive and is impacted by other factors, as well.

Regarding these other factors, there is also a novel way to look at the trade deficit in the context of whether other countries are not paying their fair share of global defense.  The military strength of the US is one factor behind the strong dollar.  Safe-haven inflows of foreign capital lifts the dollar, which in turn widens the trade deficit.  A wide trade deficit means that the US is consuming more than it produces.  This "excess" consumption can be viewed as foreign payment for US defense.  So, cutting the trade deficit would reduce this "payment." 

Away from the tariffs, the bottom line from Fed Chair Powell's post-FOMC news conference last week is that monetary policy will be steady for the foreseeable future.  More than one or two months of adverse or friendly data will be required to convince officials to change policy.  He said current policy and the economy are "well positioned."  And, Fed officials are not "in a hurry" to change policy.  

This week's key US economic data are not expected to move the Fed.  Consensus looks for a moderate January Employment Report and little change in the Mfg ISM.  Nonfarm Payrolls are seen increasing  170k m/m, equaling the Q424 average m/m pace.  It would be below the 186k average m/m pace in all of 2024.  Some softening in January job growth could stem from the extremely cold weather in parts of the country during the month.  It could have prevented some construction or other work, holding down jobs or workweek or both.  Such weakness should be viewed as temporary.

The Unemployment Rate is expected to be steady at 4.1%.  However, there is downside risk, as the consensus Payroll estimate exceeds the 125k pace that is roughly consistent with a steady Unemployment Rate.  Consensus  also looks for Average Hourly Earnings to rise 0.3% m/m, which would be an acceptable pace for the Fed.  Powell, himself, does not believe wage inflation is a problem.  He asserted that the labor market is "not a source of inflationary pressures."

Consensus sees an uptick in the January Mfg ISM to 49.5 from 49.3 in December.  (This Report will contain historical revisions stemming from new seasonal factors.)  This would keep the Index above the 48.1 Q424 average and be the highest level since March 2024.  Nevertheless, the level is still historically low and signals a sluggish manufacturing sector.  It is probably too soon to see any impact from the tariffs in this survey.  It took a long time for the Mfg ISM to show the effects of the US/China trade war in 2018, as it stayed at a high level until November.

Tariffs Loom, But OK FOMC Meeting and US Economic Data

The stock market may trade cautiously ahead of the February 1 deadline regarding 25% tariffs on Mexico and Canada.  Trump could go through with them (a market negative) or hold back and announce negotiations (a market positive).   The market should take this week's FOMC Meeting in stride.  Although the Fed will not cut rates, it will likely keep open the door for cuts later this year if needed.  Corporate earnings as well as this week's key US economic data will likely be market positives. 

Trump's threat to impose 25% tariffs on imports from Columbia is minor compared to such a tariff on Mexico and Canada.  US imports from Columbia were about $18 Bn last year, versus about $900 Bn from Mexico and Canada combined.

There are two reasons to expect the Fed to keep monetary policy steady at this meeting.  /1/ The macroeconomic background does not call for lower rates.   GDP Growth is strong and the labor market solid.  Underlying inflation is on the desired downward path, but the pace is still too high.  /2/ Trump's insistence that rates should be cut almost guarantees the Fed will not do so.  Fed officials need to show their independence, which they view as paramount.  Moreover, if they cut rates, inflationary implications of the implicit loss of independence would boost longer-term yields and weaken the dollar. 

In his post-Meeting news conference, Fed Chair Powell, nevertheless, will likely keep open the door for rate cuts later this year, since this possibility is part of the projections made at the December FOMC Meeting.  However, he may indicate that policy easing will happen only if warranted by economic conditions.  The trend in economic growth would have to weaken and inflation continue to slow.  (Note that the extremely cold weather in parts of the country could hurt economic activity temporarily.)  This policy stance should be positive for the stock market.  Continuing solid economic growth is good for profits, so  a steady Fed is not a problem.  Moreover, having a ready-to-ease-if-needed Fed in the background puts a floor on downside risks in the economic outlook.

Powell is likely to downplay any suggestion of policy tightening that may arise among the questions raised by reporters.  He could say this possibility was not discussed at the meeting and is not part of the officials' projections made in December.  Although economic growth appears to be continuing at a faster pace than expected by the Fed, officials will likely tolerate it for two reasons.  /1/ Strong productivity growth has been an important factor behind recent GDP growth.  To that extent, the growth should not be inflationary.  /2/ Labor cost inflation remains in check, particularly according to the broadest measure, Compensation/Hour.

Powell will not likely comment on Trump's policy proposals, such as clamping down on immigration and extending tax cuts, citing uncertainty surrounding them -- uncertainty regarding whether or to what extent they will happen and also what their effects might be.  

This week's key US economic data are expected to be market-friendly both for stocks and Treasuries.  The first release of Q424 Real GDP Growth is seen by consensus at a robust 2.7% (q/q, saar), close to the Atlanta Fed Model's forecast of 3.0%.  Consensus also sees a benign 0.2% m/m increase for the December Core PCE Deflator.  Although the modest December CPI suggests downside risk to the PCE Deflator, the large increase in PPI Airfares will feed into the PCE Deflator and stands as an offset.  The y/y for Core should be steady at 2.8%, but an uptick to 2.9% can't be ruled out.  Consensus expects the Q424 Employment Cost Index (ECI) to slow to 1.0% (q/q) from 1.1% in Q324.  Average Hourly Earnings (AHE)  supports the idea of a slowdown in the ECI, as speedups/slowdowns in the AHE were matched by the ECI a quarter ahead in 5 of the past 6 quarters (see table below).

                             (q/q percent change)

                          AHE                        ECI 

Q423                1.0                            na 

Q323        1.0     1.1

Q223        1.2     1.0   

Q123                0.8                            1.2                  

Q422                1.2                            1.1

Q322                1.1                            1.2

Q22                  1.1                            1.3   

Q122                1.3                            1.4

    

A Less Problematic Trump?

The stock market may be buoyed over the next couple of weeks by favorable corporate earnings reports and relief that Trump's tariff plan may not be as disruptive as feared.   In addition, Trump's intention to ease regulations and extend his earlier tax cuts should be supportive in the background.  It could add to a relief bounce on the peaceful transition of power on Inauguration Day.

News reports indicate that Trump's advisors are discussing a number of ways to implement tariffs to mitigate their inflationary impact.  These include a gradual pace of small increases over months, carve-outs for some industries, and temporary tariffs whose purpose is to persuade a country to change its approach to border control and drug trafficking.  Any moderation in tariff implementation would likely be viewed positively by the markets for having a smaller inflationary impact.

To be sure, a tariff would not only boost import prices (with the caveat that importers may not pass them through and that the stronger dollar will be a partial offset) but also prices in domestically-produced substitutes.  Demand would shift away from imports to the latter, allowing firms in that industry to raise prices.  The latter's increased revenue could boost profits or wages or both.

Corporate earnings should be helped by the strong economy.   The Atlanta Fed model's latest estimate is 3.0% for Q424 Real GDP Growth.  The Claims data indicate the labor market continued to strengthen in early January.  Initial and Continuing Claims so far are below their December averages.    

Meanwhile, inflation ended last year on a soft note.  The 0.2% m/m Core CPI in December showed a further increase in the share of components with 0.2% or lower prints.  Upcoming inflation reports for January and February will be important, as they will show whether there is any moderation in the typical start-of-year price hikes.  Last year, the Core CPI rose 0.4% in both months.  It is a potential window for a notable decline in the y/y pace for the Core CPI.  The latter was 3.2% in December.

                               Number of Major Core CPI Components 

                                   0.2% or Less                     0.3% or More

          Dec                   11              5

      

        Nov             9           7

Oct                                     7                                         9                                 

Sep                                    9                                         7

Aug                                  13                                         3

July                                    8                                         8

June                                 13                                        3

May                                  11                                        5