New Tariff Regime May Not Change Picture

The stock market may continue to trade in a range this week, with the threat of a US attack on Iran perhaps the biggest temporary risk.  The fall-out from the Supreme Court's ruling against Trump's tariffs also will be playing out in the background.  It is not likely to move the Fed off its steady policy position in the near term, so would likely be viewed by the market as noise, particularly since Trump's replacement of the old tariffs by a 15% tariff will mitigate any impact.   Evidence of a softer labor market, both in terms of jobs and wage inflation, may be more important.

At this point, it appears that Trump will use another law, rather than the national emergency rationale, to justify some form of tariffs.  So, the near-term impacts on inflation and the federal budget from the Court's decision may be minor.  The trade-off between lower inflation and higher federal deficit may become important for the long end of the Treasury market at some point.   Moreover, even if the net change is lower tariffs and tariff refunds, they would represent a tax cut that should help consumer spending and thus growth.  So, there would be little need for a boost to the economy from easier Fed policy.

Meanwhile, last week's US economic data did not change the overall picture.  Growth is moderate and inflation sticky.  Although Q425 Real GDP Growth came in at a below-consensus 1.4% (q/q, saar), it was held down by a temporary drop in federal government purchases stemming from the shutdown.  The drop subtracted 1.15 percentage point from the GDP growth rate.  This drag, however, is now a propellant for GDP Growth in Q126.  The Atlanta Fed model's first estimate of Q126 Real GDP Growth is 3.1%.

The Unemployment Claims data are telling a divergent story.  Lower Initial Claims show a decline in layoffs.  However, higher Continuing Claims show reluctant hiring by companies.   Although one more week of data is needed to complete the evidence from Continuing Claims, they now point to a smaller increase in Nonfarm Payrolls in February than the +130k m/m in January.  A small increase could encourage expectations of Fed easing ahead.

The high PCE Deflator in December (0.4% m/m for both Total and Core, with their y/y steady or higher) was not good news for the Fed.  It was the second month in a row that these measures of inflation exceeded the corresponding pace in the year-ago month.  The inflation outlook is more uncertain now that the tariff situation has changed.  The net effect may be to lower inflation in the next few months.  This should be viewed as temporary by the Fed and may not be enough to prompt a policy easing.  What may be more important is evidence that labor cost inflation is slowing, as already seen in the Q425 Employment Cost Index.  Near term, declines in the y/y of Average Hourly Earnings could be key.

 

 

 

 

 

 

 

 

 

 

 

 

  

Little Change in Macroeconomic Background

The stock market may continue to churn in a range this week, as the macroeconomic background is expected to be little changed by key data.  The latest data show that growth looks solid, the labor market sluggish, and inflation sticky.

The shutdown-delayed Q425 Real GDP Growth finally will be released this week.  Although the market will likely view the Report as "history," it would underscore that the underlying pace of the economy is solid, as Fed Chair Powell says.  Consensus looks for Q425 Real GDP to rise 3.0% (q/q, saar), not much different from the latest Atlanta Fed Model estimate of 3.7%.  The Q4/Q4 pace would be 2.6-2.8%, stronger than the 2.4% in 2024 and the Fed's estimate of 1.8-2.0% for longer-run potential growth.

A GDP print in line with consensus or the Atlanta Fed Model estimate would point to another quarter with strong productivity growth -- a positive for the inflation outlook.  Total Hours Worked (THW) rose only 0.7% (q/q, saar) in Q425.  Strong productivity likely reflects companies' attempts to become more efficient, possibly in part by incorporating AI into their operations.  These attempts could explain the modest Payroll gain in January outside of health care.  Private Payrolls rose only 48k, as Health Care and Social Assistance jobs accounted for 124k of the 172k increase in Total.  The absence of a broad jobs gain in January is indicative of a sluggish labor market. 

The January Employment Report showed that companies may be relying on longer hours of work, besides increasing productivity, to produce goods and services.  The Nonfarm Workweek edged back up to 34.3 Hours from 34.2 Hours in December.  The longer workweek lifted THW, putting the January level 1.5% (annualized) above the Q425 average.  This raises the possibility that Q126 Real GDP Growth will be strong, as well.  While the extremely cold, snowy weather in much of the country during late January and early February may act as a drag on economic activity, the chances are that much of the weather-related shortfall will be made up late February and March.  Or, the weather-rebound could boost Q226 Real GDP.

The January CPI Report had encouraging news for the inflation outlook.  However, it was far from showing that inflation is no longer a problem.   The most important news may be that inflation was more benign in the first month of the year than is typical.  This is seen in the decline in the y/y change.  The return in Owners' Equivalent Rent to 0.2% m/m also was good news.  This large component of the CPI may need to maintain this pace or lower for the Fed to achieve its 2% inflation target.  The problem, however, is that the majority of CPI items in January had price increases of 0.3% m/m or more.  A more pervasive slowing is needed to convince the Fed that its goal has been met, which is conceivable as the economy moves past start-of-year price hikes and the impact of tariffs.  Moreover, the component with the largest drop, Used Car Prices, is not in the PCE Deflator.  So, the risk is that the latter will be higher than the CPI.  Nevertheless, last week's release of a lower-than-expected 0.7% q/q for the Q425 Employment Cost Index is a favorable indication that underlying inflation may be contained.

 

 

 

 

 

 

  

This Week's Key US Economic Data -- Much Uncertainty But Will They Help Stocks?

The stock market may trade cautiously into key US economic data this week, as they are subject to greater-than-normal uncertainty.   Nevertheless, consensus prints would likely be market positives.  

There is more than normal uncertainty regarding January Nonfarm Payrolls since they will reflect benchmark revisions, new seasonal factors and a revised "birth-death" model that estimates the net change in jobs from new companies less those going out of business.  Consensus looks for +70k m/m Payrolls, a speedup from +50k in December and +49k 2025 average.  Consensus expects Private Payrolls to rise by 70k, as well.  They rose 37k in December.  

There are two ways to use the ADP Estimate and Continuing Claims to predict speedups/slowdowns in Private Payrolls.  One way is to see whether the m/m change in them speed up or slow down -- just compare the m/m change in one month with that of the prior month.  The other way is to use the change in the m/m change -- the second difference.  For this, compare the change in the m/m change with that of the prior month.  Most of the time, these two ways have given the same prediction.  But, this was not the case in December.  The m/m change in Continuing was +30k in December, a speedup from +14k in November (see first table below).  The difference in these monthly changes was +16k in December and +55k in November (14 - -41k), pointing to a slowdown.  Private Payrolls in fact slowed in December, consistent with the second difference. 

Both the m/m change and the second difference in the ADP Estimate point to a slowdown in January Private Payrolls.   In contrast, both the m/m change and the second difference in Continuing Claims point to a speedup.  Continuing has done a better job than ADP in predicting speedups/slowdowns in Private Payrolls, and they support the consensus expectation of a speedup.  A near-consensus Payroll print may calm market fears of slow growth in early 2026.  Consensus estimates of solid gains of around +0.5% m/m for January Retail Sales, both Total and Ex Auto, also should mollify such fears.  

Consensus also expects a steady 4.4% January Unemployment Rate and a near-trend +0.3% m/m increase in Average Hourly Earnings.  These should not be problematic for the markets.  Subdued wage inflation is also expected for the Q425 Employment Cost Index.  Consensus looks for +0.8% q/q, matching the low print of the prior quarter (see second table below).  However, Average Hourly Earnings suggests upside risk, although not by enough to be of concern for the inflation outlook.  

There is a lot of uncertainty surrounding the January CPI, too.  It could be impacted by start-of-year price hikes and pass-through of tariffs on the upside and possibly an unwinding of one-off catch-up price jumps in the December CPI emanating from survey problems caused by the government shutdown.  Consensus looks for +0.3% m/m for both Total and Core.  Although these increases are above the pace consistent with the Fed's 2% target, the y/y would fall for both, moving them closer to the target.  Y/Y for Total would fall to 2.5% from 2.7% in December.  Y/Y for Core would fall to 2.5% from 2.6%.

                                       Private Payrolls (m/m change, 000s)   

                        ADP Estimate        First-Print BLS        Latest-Print BLS    Continuing Claims *        

    March               155                          209                            120

    April                   62                          167                            133                               14                            

    May                    37                          140                              69                              -74           

    Jun                    -33                            74                             -27                              -57                              

    Jul                    104                            83                               77                               18   

   Aug                     54                            38                               -4                                 2                            

   Sep                    -32                           119                              104                             28 

   Oct                     42                             na                                  1                             -41 

   Nov                   -32                            69                                50                               14

    Dec                   41                            37                                 na                               30     

    Jan 26               22                            na                                 na                               86                                    

 * the inverted change in Continuing Claims between Payroll Survey Weeks, 000s                 

                             (q/q percent change)

                            AHE                ECI 

Q425                    1.0                    

Q325                    0.9                    0.8

Q225                    0.8                    0.9

Q125                    1.0                    0.9                             

 

Two Market-Important Developments

The stock market may be beginning to adjust to two developments:  /1/ a lower probability of Fed easing ahead and /2/ a reaction of other countries' trade policy to Trump's tariff regime.  The latter is probably the more significant market negative.  It could hurt stocks through a weaker dollar and higher longer-term yields.  Strong US economic growth and corporate earnings, however, may temper any downward adjustment by stocks.

This week's key US economic data are expected to be on the stronger side, reinforcing the Fed's decision last week to keep the funds rate steady and downplaying the possible need for easier monetary policy ahead.  Both the Mfg ISM and Nonfarm Payrolls are expected to improve in January -- despite the cold/snowy weather in parts of the country.  However, the implication of steady monetary policy should not be a problem for the stock market as long as economic growth is strong.  The latter ensures continued solid corporate earnings.  Moreover, as "insurance," the Fed would be ready to resume easing if the economy weakens.

Consensus looks for the Mfg ISM to rise to 48.3 in January from 47.9 in December.  This would be its highest level since September (49.1).  Some of an increase could be catch-up, since gains in both Durable Goods Orders and Manufacturing Output (part of Industrial Production) suggest the December Mfg ISM was too low -- although the weakest component that month was Inventories, not New Orders or Production.  

Consensus looks for Nonfarm Payrolls to speed up to +70k m/m from +50k in December.  Unemployment Claims data support the idea of a speedup, particularly Continuing Claims which fell a good deal since the December Payroll Survey Week.  Consensus also looks for a trend-like 0.3% m/m increase in Average Hourly Earnings.  Its y/y would fall to 3.6% from 3.8%.  However, there is more than typical uncertainty surrounding these estimates this month because the data (based on the Establishment Survey) will embody benchmark revisions, new seasonal factors and a new "birth-death" model to account for jobs created and lost when companies start and end.  It will be interesting to see if the Fed's estimate of a 60k overstatement of m/m changes in Payrolls will show up after these technical changes have been made.

The Unemployment Rate will not be affected by these technical changes because it is measured from data collected in the Household Survey, whose annual revisions were incorporated in the data last month.  Consensus looks for a steady 4.4% Unemployment Rate.  Rounding analysis suggests a steady Rate is more likely than a decline.  Since the Rate's un-rounded level was 4.44% in December, it will take a full 0.1% pt decline to get to 4.3%.  Nevertheless, a decline in the Rate should not be ruled out, given the drop in Continuing Claims.     

The moves by Canada and Europe to negotiate lower tariffs with China and India may be a greater problem for the stock market.  Their moves are logical reactions to the tariffs imposed by the US.  Since the latter will likely reduce their exports' share of the US market, it makes sense for them to find other markets to sell into.  

The channel to the stock market runs through the FX and longer-term Treasury market.  The countries' shift away from the US could reduce the role of the dollar in international  trade, lowering its value in the FX market.  A weaker dollar can have inflationary consequences and thus boost inflation expectations.  The latter, in turn, could lift longer-term Treasury yields.   So could the fewer foreign-earned dollars available to buy Treasuries.  The higher yields are a negative for stocks.  To be sure, a weaker dollar also makes profits earned abroad more valuable in dollar terms.  However, the broader negative impact from higher longer-term yields would probably dominate.

 

 

 

 

 

 

A Somewhat Disappointing Fed?

Strong corporate earnings reports may help the stock market get through a somewhat disappointing FOMC Meeting this week.  The Fed is not expected to cut rates and the Statement will not likely change from December's -- continuing to say that "inflation remains somewhat elevated" and "the downside risks to employment rose in recent months."  However, Powell may present a more balanced view of the risks in his news conference than he has in the past few meetings. 

Powell may feel less compelled to lean toward a Trump-desired policy easing because of the threat to Fed independence stemming from the DoJ's investigation into his Congressional testimony.  Even without this political interference, the US economy appears to be doing well and not needing further monetary policy stimulus.  Evidence to this effect is seen on both the real and inflation side of the economy.  Nonetheless, a Fed ready to ease if needed should be seen as providing positive support for stocks in the background.

The Atlanta Fed Model now predicts 5.4% for Q4 Real GDP Growth, which would be the third strong quarter in a row.  Good-sized gains in October and November Consumption support the model's prediction for Q425 Real Consumption.   Some of the model's predictions of other components of GDP are questionable, however.  So, the model's prediction should be viewed with caution at this point. 

Importantly from the Fed's perspective, the economy's strength may be finally helping the labor market, seen by the ratcheting down in Initial and Continuing Claims in January.  Although a little early, the Claims data suggest a speedup in January Payrolls from December's +50k m/m pace.  Nevertheless, it would be premature for the Fed to change the Statement regarding the labor market at this point -- although Powell may mention the improvement in Claims (thereby damping the downside employment risk in the Statement).

The economy's strength may be a factor in the steady inflation rate seen over most of last year.  The Total PCE Deflator rose by 0.2% m/m in 5 of 8 months since April 2025.  The Core PCE Deflator rose 0.2% in 7 of the past 8 months.  Both rose 0.2% in December.  Their 2.7-2.8% y/y, the longer-term measure Powell likes to refer to, remains above the Fed's 2.0% target.  The shorter-term 3-month annualized increase also is somewhat above target, with Total at 2.5% and Core at 2.3%.

The next couple of CPI reports will be important to see the size of start-of-year price hikes.  Companies could use them as an opportunity to more fully pass through the tariffs.  However, there could have been measurement problems behind some of the large price hikes seen in the December CPI, stemming from the government-shutdown-resulting delays in sampling.  The affected components could settle down in January or February, which month depending on whether bi-monthly sampling is used.  If it is used, then the price jumps in the December CPI could show up in the January CPI to some extent.

All this evidence argues for the Fed to take as wait and see approach to monetary policy.  Whether the tariffs' boost to prices turns out to be one-off should be evident by the Spring.  And, whether AI results in widespread job losses could show up by then, as well.  The window for a Fed easing may open up in a few months depending on how these developments turn out. 

 

 

Supreme Court Hurdles

The stock market may have to contend with important Supreme Court rulings on the Fed and tariffs this week.   On Tuesday, the Court may release its decision on whether Trump can fire Fed Governor Lisa Cook and whether Trump's tariffs are legal.  Possible market reactions are discussed below.  Favorable corporate earnings reports should cushion any market-unfavorable ruling.  

The stock market's reaction to a Court decision could depend on how the latter impacts longer-term Treasury yields.   A decision permitting Trump to fire Cook could be viewed as a step towards undermining Fed independence.  This would exacerbate future inflation risks, resulting in a steeper yield curve --which would be a negative for stocks.  To be sure, a replacement for Cook, along with a new Fed Chairman in May, would lift the probability of Fed rate cuts this Spring.   However, this possibility is likely too far ahead to provide a noticeable boost to stocks now.

In contrast, a Court ruling against Trump's authority to fire Cook could bolster the idea of Fed independence.  The yield curve should flatten, which would be a positive for stocks.  A decision that does not address Trump's authority to fire a Fed Governor but allows Cook to keep her job may have a minor impact on the stock market.  The question of Fed independence would just remain in the background and be ignored for now.  Such decision, however, could dampen the probability of a rate cut this Spring, making it more dependent on upcoming US economic data.

A Court decision permitting Trump's tariffs could be a positive for the stock market.  It would retain the government's collection of tariffs that have helped reduce the Federal Deficit, which is a positive for longer-term Treasuries and thus stocks.  The inflation boost from tariffs may be mostly behind us, so it could be a less important implication for the markets.  However, since it would leave open the door for Trump to impose more tariffs by whim, it would maintain a degree of uncertainty in the economic outlook that could hurt growth.  This impact would remain to be seen, so should not have an immediate effect on stocks.

A decision against Trump's tariffs could lift longer-term Treasury yields, a negative for stocks, because it would lift estimates of the Federal Budget Deficit.  However, since Trump has said there are other ways to maintain tariffs besides his declaration of a state of emergency, the markets' reaction may be muted.

Meanwhile, the macroeconomic background appears to be shifting against the need for a Fed rate cut.  Although the headline December CPI was benign, with Total +0.3% m/m and Core +0.2%, the composition did not show widespread softness.  There were a number of large increases, possibly related to tariffs or to lingering issues from the government shutdown's interference with the CPI survey.  The Fed will likely wait to see a sustained broader pattern of modest inflation before saying inflation is "licked."

The real-side of the economy appears to be doing well.  The Atlanta Fed Model's latest estimate of Q425 Real GDP Growth is 5.3% (q/q, saar) -- implying another quarter of strong productivity growth.  Manufacturing Output in the Industrial Production Report has picked up over the past two months from a flattish span in the prior three months.  And, the labor market may have begun to improve, seen in the downward trend of Unemployment Claims over the past three or four weeks.  

 

Strong Corporate Earnings Season Begins, CPI on Docket

The stock market may continue to rally this week, as expected strong corporate earnings reports begin to be released  However, there could be some caution going into Tuesday's release of the important December CPI.  The consensus estimate is not soft enough to back a Fed rate cut at the January 27-28 FOMC Meeting.  A below-consensus print for the Core CPI cannot be ruled out, nonetheless.

Consensus looks for +0.3% m/m for both Total and Core CPI for December.  The y/y would be steady at 2.7% for Total and move up to 2.7% from 2.6% for Core.  Both the m/m and y/y would not show any movement toward the Fed's 2% inflation target -- arguing against a January Fed rate cut.  

There are mixed considerations regarding whether the Core CPI prints 0.2% or 0.3%.  There is a decent chance that the Total CPI will print 0.2% even if the Core rises 0.3%.  

Supporting the consensus 0.3% estimate, tariffs could continue to lift some prices.  And, Airfares could rise thanks to seasonal factors.  They add to Airfares in December after subtracting in October and November.  Owners' Equivalent Rent could be a problem, as mentioned below.   

Lower-than-consensus CPI prints are possible, however, but likely require Owners' Equivalent Rent (OER) to stay low at 0.1% m/m and Airfares and Lodging Away From Home to be little changed.  /1/ OER appeared to have been estimated at 0.1% for both October and November by the Bureau of Labor Statistics (BLS).  It fits with private surveys indicating a slowdown in rents.  However, if the December survey shows the BLS estimates were too low, the entire correction could be put into the December OER, causing the latter to jump.  /2/ Seasonal factors boost Lodging by less in December than in November, suggesting a slowdown in the Lodging component of the CPI.   

The other important US economic data this week will be December Retail Sales.  Consensus looks for good-sized increases of 0.4% m/m for both Total and Ex Auto.  The latter would match the November gain.  A consensus-like print would show that the weak labor market is not severely hurting consumer spending.  A boost to consumers' wealth from stock market gains could be the offsetting factor fueling consumption.  Solid consumption growth is embodied in the Atlanta Fed Model's latest (but early) estimate of a very strong 5.1% increase in Q425 Real GDP Growth.  As it stands, the latter points to another quarter of strong Productivity Growth --  a positive for corporate earnings and the Fed's inflation fight.

The December Employment Report confirmed a soft labor market but apparently not soft enough to dampen wage inflation.  Besides a small 50k m/m increase in Payrolls, the Nonfarm Workweek fell back to 34.2 Hours from 34.3 Hours in November.  Both figures show that companies are holding back on using workers, possibly substituting AI for them.  Although the Unemployment Rate slipped to 4.4%, it remains high.  

Despite the soft labor market, Average Hourly Earnings (AHE) stayed at 0.3% m/m, the average pace in 2025.   The y/y rose to 3.8% from 3.6%.  There was better news on labor cost inflation in the Q325 Productivity Report.  Compensation/Hour -- the broadest measure of labor costs -- rose a below-trend pace for the second quarter in a row.  The y/y at 3.2% is roughly in line with AHE.  Both are consistent with the Fed's 2% inflation target once productivity is taken into account.  This is seen in the 1.2% y/y for Q325 Unit Labor Costs.  Labor costs are not the culprit behind cost pressures on prices.  The culprit is tariffs, seen in the surge in Non-Labor Unit Costs in Q225 and Q325 (7.8% and 11.6%, q/q saar, respectively).