Fed Policy, Treasuries and Tariffs

The stock market should continue to be subject to developments in the tariff situation, including commentary about the tariffs' impact in corporate earnings reports.  Although Fed monetary policy is now on hold, officials too will be focused on the potential drag on economic activity and boost to inflation from tariffs.  Besides Fed policy, the risk of massive selling of longer-term Treasury securities is not independent of tariff developments.  In the background, Trump's attack on Powell could develop into a big problem for financial markets.

Fed Chair Powell commented last week on the framework the Fed will use to decide on monetary policy once it sees effects of the tariffs.  He said whether to tighten or ease will depend on how far each of its mandated targets -- unemployment and inflation -- is from its goal and how much time each would be expected to take to return to goal.  Presumably, policy would be focused more on the target that is slower to return.  Powell said the tariffs may push the targets away from their goals for the "balance of the year."  He also underlined the importance of restraining inflation expectations.  Currently, the Fed is in no hurry to change policy.  As I mentioned last week, the optimal solution to this quandary is to let the unemployment rate rise at first and then ease policy.  This would allow the economy to recover without putting upward pressure on wage inflation. 

Powell did not discuss whether loss of confidence in the US will result in massive selling of Treasury securities, most likely because it is not in the Fed's purview.  However, it remains a potential problem for stocks and the economy.  The possibility of significant confidence loss is not independent of tariff policy.   On the one hand, a winding down of the tariff issue, perhaps by Trump's paring down the size of tariffs for those countries with which there is successful negotiations, could restore confidence in the US and end the dumping of Treasuries.  This would likely result in a decline in longer-term Treasury yields and stronger dollar -- a double positive for the stock market.  On the other hand, a worsening in the tariff situation could prompt greater loss in confidence and more Treasury/dollar selling -- a double negative for stocks. 

Trump's complaint that the Fed should ease and that Powell should be fired would probably backfire if carried out.  Both would be viewed as /1/ inflationary and /2/ undermining Fed independence.  They would result in higher longer-term yields and weaker dollar -- negatives for the stock market.  Trump cannot legally remove Powell as Fed Chair while his term lasts through May 2026.  This, however, may not stop Trump from trying, as his staff is reported to be looking into how he might be able to fire Powell.  A soft Q125 GDP report, due April 30, could raise the pitch of Trump's tirade.  His attack on Powell appears to be an attempt to shift the blame for the financial market sell-offs and economic slowdown to the Fed from tariffs. 

 

 

 

 

Stocks Range Bound?

The stock market may stay in a range near term, helped by some easing in the tariff situation but hurt by higher longer-term Treasury yields and weaker dollar.

The worst of the tariff situation may be over.  China has said it will not retaliate further.  And, headlines could turn market-positive as bi-lateral negotiations with other countries occur.  Also, the Administration's idea regarding natural gas exports could resolve the situation positively.  The next positive surprise could be if China and the US agree to talks to diffuse the issue.  However, until then the impact of the large tariff on Chinese goods remains to be seen. 

The sell-off in Treasuries and the dollar, however, could become a major problem for stocks.  It may show waning demand for US assets stemming from bad tariff policy by the US.  Or, it could result from higher inflation expectations, also stemming from the tariffs.  The latter is seen in the jump in 5-year inflation expectations in the University of Michigan Consumer Sentiment Survey to 4+% from the former 3% trend.  The jump in longer-term inflation expectations runs counter to the Fed's idea of a one-off impact of tariffs on prices.  The Fed may be forced to tighten at some point as a result of these market moves.

In contrast to these fears, the US economy so far remains solid with little inflation.  Unemployment Claims stayed low in early April.  Inflation also is not problematic.  Ironically, the low March CPI in part reflected large price cuts that might have resulted from a tariff-induced pullback in demand in -- airfares and hotel rates.  The direct boost from the tariffs is yet to be seen.  There is no reason from these fundamental data for the Fed to change its steady policy stance.

Here are some thoughts on the trade deficit and tariffs.

 Explaining the Trade Deficit -- Several Ideas

1.  Trump pushes this idea: The deficit results from unfair practices of US trading partners.  These include subsidizing exports, dumping products and manipulating currencies.  These practices should be addressed, but universal, high tariffs would seem to be excessive as the unfair practices are likely concentrated in only a few countries and can be addressed with more targeted policy tools.  

    a.  China is the major perpetrator.  Their actions stem in part from central planning, for which the typical result is overproduction relative to demand.  China dumps the excess supply onto the rest of the world, depressing prices and undercutting manufacturing in other countries.  Many economists have argued that China should boost its domestic demand, in part by structural changes. 

2.  Some economists blame the US for the deficit.  They say the deficit results from inadequate saving, that is excessive consumption, by the US.   Their argument is based on an identity in GDP accounting that equates national saving to the trade balance.  A trade deficit equates with a saving shortage.  There is almost a moral criticism in this explanation.

3.  A third explanation:  The deficits result from the desire of other countries to hold US dollars.  Financial inflows lift the dollar in the FX market, thereby hurting exports and boosting imports. Countries are willing to produce for the US in exchange for paper debt.  The deficits can be interpreted as compensation to the US for having a global currency with a dependable legal system behind it.  The current sell-off in Treasuries and dollar raise the possibility that this cause of the trade deficit is ending.

Trump's tariffs address the first two explanations.  The reciprocal tariffs are supposed to be geared to unfair trade-related actions of each country.  And, as a tax, they result in forced saving by the US.  Even if these are viewed as justifiable reasons to cut the trade deficit, the magnitude of the tariffs remains an issue.

If Trump viewed the trade deficit the third way, he'd likely see it as a good deal -- an exchange of paper for goods and services.

From the perspective of the third explanation, eliminating the trade deficit through tariffs could lead to a dollar shortage.  This would strengthen the dollar in the FX market, offsetting the impact of the tariffs and leading to a renewed US trade deficit.  However, it could result in other currencies playing a larger role in international trade and finance, pushing down demand for dollars and hurting the US position in the world economy.  The current weakness of the dollar in the FX market and increase in Treasury yields could be anticipatory of this scenario.

Is Elimination of the US Trade Deficit With Tariffs a Good Goal?  

1.  Good Goal:  Labor unions think so because fewer imports could shield them from competition with the global labor force. To be sure, although their members could bargain for higher wages, they would be hurt by higher prices on goods and services they consume as well as by a recession if precipitated by tariffs.  

2.  Good Goal: Cutting the trade deficit would slow the move of the US into being a net debtor.  By going into debt to the rest of the world, the US provides other countries with the means to buy US assets.  Part of US production then would go to foreigners as dividends, profits or interest.  The US would be working in part for others, not a good outcome.  However, foreign purchases of US assets could be controlled by Presidential or Congressional actions, so a general tariff may not be necessary.

3.  Good Goal: Re-shoring production could make the US less vulnerable in a political or military conflict.

Bad Effects of Eliminating the Trade Deficit With Tariffs

1.  The US standard of living will decline if the deficit is eliminated by cutting imports.  The standard of living had been propped up by the amount of the trade deficit, which represents the amount the country spent beyond its income.  

2.  The tariffs' role as a tax would be behind the decline in the standard of living.  

2.  Replacing the international supply nexus with a domestic system would be costly to implement.  

3.  Once implemented, a domestic system would be more costly to operate than the international supply nexus, otherwise it would have been in place already.

4.  The range of goods available to US consumers could shrink, as some goods become too expensive to market. 

 Exporting Natural Gas

1.  The Administration has raised the possibility of substituting other countries' purchases of US natural gas for tariffs as a way to eliminate the trade deficit.

2.   Boosting exports of natural gas instead of cutting imports by imposing tariffs would eliminate the tariff's bad effects.  And, it would boost US GDP. possibly with little strain on the labor market.

3.  It would eliminate the benefits from reducing foreign competition for unions and moving the US further into a net debtor position. 

4.  It would likely lift natural gas prices.

A Little Appreciated Benefit of the Trade Deficit

1. The aging US population means that more working-age people will be needed to support the country's standard of living.  Immigration is one solution.  However, Trump's anti-immigration policy closes that door.  Running a trade deficit allows the US to take advantage of working-age people abroad without incurring the costs associated with immigration. 

 

Trump Tariffs Still A Problem, But...

The stock market and other financial markets are setting up for their fears of what may stem from Trump's tariffs -- recession and the costs of major shifts in the global economy.  However, it will take time to determine how the fall-out from the tariffs plays out, as discussed below.  So, the market sell-off may become excessive if the worst of the fears don't happen, and some recovery near term is possible.  This week's release of the March CPI could help, as it risks being soft (consensus is 0.1% m/m Total and 0.3% Core, which can't be ruled out but risks being too high).  To be sure, an end of the sell-off may require the stock market to overshoot and hit an important support level.  Or, the market may find relief if there is movement by countries to negotiate with the US. 

1.  Tariffs as a Tax on the Consumer

Expectation of a recession stems from the role of tariffs as a tax on the consumer.  Assuming full pass-through of the tariffs to prices and no change in spending composition, Trump's tariffs would cut consumers' purchasing power by $1Tn per year, including the tariffs on steel, aluminum and autos, according to news services.   This represents about 3.5% of GDP, making it the largest tax hike relative to GDP since 1942 .   

The drop in Real GDP would be less under some scenarios.  /1/ If people reduce their saving rather than spend and pay the higher prices.  /2/ If people shift the composition of their spending toward domestically-produced goods and away from imports.  /3/ Other countries cut their exports or their prices to the US.

2.  Prices of Domestically-Produced Goods

The drop in Real GDP could be worse if domestic producers lift their prices, taking advantage of weakened competition from imports.  Price hikes by domestic producers would eliminate the ability of consumers to avoid paying the tariffs by shifting the composition of their spending.  The hikes by themselves would cut consumer purchasing power (and boost the companies' profits), as well.  So far, however, a couple of domestic auto companies have cut prices temporarily.  One auto company is holding prices steady at this point.  

3.  Shift in Demand to Domestic Producers

A shift to domestically-produced goods, as apparently some auto companies have begun to do, not only could allow consumers to avoid paying the tariff, it would boost GDP.  At the extreme, there would not be a recession but instead stronger economic growth.  The problem then would be that the increased domestic production would have to displace other domestic production if the economy is operating near full capacity (as it is now).   In particular, demand for labor could climb and exert upward pressure on wage inflation.  Higher interest rates, weaker stocks and higher inflation are ways the markets would accomplish the "crowding out."  When the economy is operating at full employment, the eventual outcome would be the same level of GDP as what would have been the case without the tariffs, but the composition of output would differ.

4.  Retaliation

Some countries already have responded to the tariffs by imposing their own.  Anger at the US reportedly has prompted Canadians to cancel travel to the US, which is a reduction in US services exports, and to impose tariffs on some US motor vehicles.   China is about to impose tariffs on US goods.  It also has retaliated by limiting sales of rare earth minerals.  The next shoe to drop could be the European Union, although some European countries (eg Italy and Ireland) appear to be arguing against or for modest retaliation.  Vietnam appears to be moving in that direction, as it has offered to drop all its tariffs on US goods.  Note that dropping its tariffs may not be enough to placate Trump -- Vietnam controls its currency and may be holding it down relative to the dollar.

5.  Price Inflation

There are several ways that tariffs could precipitate higher price inflation.  /1/ A pass-through of the tariffs, /2/ matching price hikes by domestic producers, /3/ shortages created by other countries'  retaliatory actions,  and /4/ higher wage inflation resulting from increased demand for labor or from a push by labor to catch up to the higher prices.  

These channels may take time to work through.  So, inflation measures, like the CPI and PCE Deflator, could have high prints for a number of months, even if the pass-through is one-off as the Fed thinks is likely.  A full pass-through of the tariffs would boost the PCE Deflator by 5%.  Wage inflation will be important to watch.  A speedup in wages would suggest that a "wage-price spiral" is a more likely consequence of the tariffs than the one-off idea.

6.  Fed Policy

The Fed will eventually cut rates to fight recession, but may be slow to do so while inflation stays high.  The Fed would manage both issues well by first letting the economy weaken and unemployment rise and then easing to end the recession.  Creating labor market slack initially would allow the economy to resume growing without boosting inflation.

7.  Fiscal Policy

Trump may be hoping that an extension of his earlier tax cuts will offset the drag from tariffs.  However, the extension shouldn't be viewed in the way done by the Congressional Budget Office (CBO).  The CBO measures it against a baseline where the tax cuts are allowed to expire.  Doing so, CBO estimates the extension would cost $4.6 Tn over 10 years.  This is the 10-year sum, not the annual amount.  In terms of offsetting the tariffs, however, it is the sequential change that matters.  And, a simple extension would add zero sequentially.  So, it would not offset the drag from tariffs.

 

 

Fear of Fall-Out from Trump Tariffs

The stock market may continue to be fearful of the fall-out from Trump's tariffs, with the big announcement of reciprocal tariffs on April 2.  At this point, the fear is that economic growth and corporate earnings will be hurt, while inflation will speed up.   This week's key US economic data may be viewed as too early to indicate any tariff effects.  The market may get clarity on individual company impacts during the Q125 earnings season in April. 

Overall, Trump's intention appears to be to bring manufacturing production back to the US from abroad.  While the economy is operating close to full capacity, this result would likely be accomplished through a shift in resource allocation rather than by higher-than-otherwise overall activity.  To some extent, cutbacks in government jobs and spending free up resources for this purpose.  The markets could move in ways to accomplish it, as well.  For example, higher interest rates would depress construction activity and higher prices would depress consumption.  At the end, overall GDP would be about the same but the composition different.

The 25% auto/truck tariff may not hurt domestic motor vehicle manufacturers as much as feared.  They would capture market share as sales shift from imports to their less expensive cars and trucks.  Raising prices could help profits, as well, but it would have to be balanced against losing unit sales as a a result.  This could be an important restraint on price hikes, as the "price elasticity" of vehicle demand is estimated to be high (see below).

The companies' profitability would be hurt, however, if the higher costs of parts can't be passed through to prices fully.  For example, the company that uses imported parts the least presumably would raise prices the least. This could exert competitive pressure on other companies, dissuading them from passing through the full increase in costs.   Trump's warning to domestic producers not to take advantage of the tariffs to raise prices also could weigh on pricing decisions.  In contrast, auto companies might be able to cut other costs of production that offsets the effect of the tariffs at least in part. 

There may be some unintended consequences, as well.  /1/ From a macro perspective, an increase in demand for labor could boost wages and thus price inflation beyond the initial impact from the tariff.  This result could necessitate tighter monetary policy.  /2/ The tariffs could shift resources into "old" industries, hurting the ability of "new" industries, such as robotics, to expand profitably.  /3/ The tariffs could help the environment by reducing demand for motor vehicles.  However, an increased use of older, less efficient vehicles could worsen it.

Here is some background information regarding how tariffs may impact demand for motor vehicles:

Price Elasticity:  This figure shows the percentage change in demand for a one percent change in price.  The smaller the price elasticity of demand for vehicles, the smaller the decline in vehicle demand from a pass-through of the tariffs to prices. An extreme example would be completely inelastic demand.  In this case, there would be no decline in vehicle demand for a full pass-through of the tariff.  

The consensus estimate for the price elasticity of motor vehicles is about -1.0.  This means that a 1 percent increase in price results in a 1 percent decline in demand.  The price elasticity is higher for lower-income than upper-income people.  

The cross elasticity between imports and domestically-produced vehicles could be higher than for the aggregate.  So, the tariff should result in a significant switch in sales to domestically-produced vehicles from imported ones.   

Tariff as a Tax:  A tariff is essentially a "consumption" tax applied to a subset of goods.  It is easy to avoid paying the tax directly -- don't buy an affected good.  It may not be easy to avoid if the "tariffed" good is used in the production of other goods or services and the latter passes through the higher priced inputs.   The tariff reduces the purchasing power of consumers to the extent it is not avoided.  

This week's US economic data are expected to show modest economic growth.  Consensus looks for little change in the Mfg ISM from 50.3.  It also looks for a slowdown in March Nonfarm Payrolls to +128k from +151k in February and an uptick in the Unemployment Rate to 4.2% from 4.1% -- still an historically low level.  A decline in government payrolls is expected to be partly responsible for the soft data.  Near-consensus prints may not calm the markets' fears by much, as the data might be viewed as being too soon to see the recessionary effects of the tariffs.  Furthermore, the risk of recession is higher when the economy's pace already is slow.

 

 

 

The Fed's Perspective On The Economy and Tariffs

The stock market may stay in a range amidst uncertainty regarding the April 2 announcement of Trump's reciprocal tariffs.  Fears that the tariffs will damage an already slowing economy as well as boost inflation may dominate any news to the contrary at this point.  However, Trump's past actions and recent words suggest there could be less than meets the eye in his threat of reciprocal tariffs, which could limit any stock market pullback ahead of the announcement.

The revised Fed's Central Tendency Forecasts reflect the market's fears, as this year's Real GDP Growth was lowered and inflation raised a bit.  These slight shifts were more an acknowledgement of the expected directions of the tariffs' impacts rather than precise estimates, according to Fed Chair Powell at his post-FOMC news conference.

The Fed is keeping an open mind about how the tariff situation develops.  Powell suggested the Fed would be able to see whether the recent uptick in goods prices reflects tariffs, presumably by seeing whether they are sustained or reversed in coming months.  Importantly, he said that the Fed expects the boost in prices from tariffs will be short-lived.  This suggests the Fed will be slow to react to high CPI/PCE Deflator prints.  It will take several months to see whether the tariffs have a persistent effect on prices. 

Perhaps the most important point made by Powell is that the Fed is focused on economic data, not sentiment surveys, in evaluating the appropriate monetary policy stance.  And, so far, the Fed does not see any impact of weak sentiments on the overall economy.  Indeed, the FOMC Statement said, "Recent indicators suggest that economic activity has continued to expand at a solid pace."  As a result of the Fed's perspective, weak sentiment surveys could become less important for the markets as long as the economic data remain robust.

Last week's US economic data were mixed with regard to the Fed's assessment of the economy.  Consumption looks soft in Q125, but possibly set up to do better in Q225.  Manufacturing Output is back on an uptrend.  The Unemployment Claims data show layoffs remain low but suggest companies remain cautious in hiring.

Consumption still looks to have slowed in Q125 despite the modest rebound in February Retail Sales.  Retail Sales Excluding Motor Vehicles and Gasoline in February were  0.3% (annualized) below the Q424 average.  However, the weakness in the first two months of the year could be just the typical pause after a strong month (December).  Also, bad weather may have played a role, in which case a bounce-back in Q225 is possible.  Supporting this possibility, the February level of Sales is 0.9% (annualized) above the January-February average.  (Retail Sales is just a part of Consumer Spending, but their weakness in January-February fits with large retailers' complaints.)

The 0.9% jump in February Manufacturing Output was led by a rebound in Motor Vehicle Production (to above the Q424 average) and continued strength in High Tech Output (computers, communication equipment and semiconductors).  Away from these two sectors, Manufacturing Output rose moderately for the third month in row -- after falling over most of H224.  This week, consensus estimate of a +0.4% m/m increase in February Durable Goods Orders Ex Transportation supports the view of an uptrend in manufacturing.

The Claims data tell a mixed story.  Initial remained low in the latest week, reaffirming relatively few layoffs are occurring.  However, Continuing rose to the high end of its recent range, suggesting hiring has slowed.  Their bounce could be volatility, though, so it's too soon to draw a firm conclusion about their implications.

The perception of the consumer may improve this week if consensus estimate of +0.6% m/m for February Consumer Spending is right.  Taking account of the consensus estimate of +0.3% m/m for the PCE Deflator (both Total and Core), Real Consumption in February would be 0.8% (annualized) above the Q424 average and 0.4% above the January-February average.  This still shows slower consumer spending than the 2024 pace, but spending remains in an uptrend.  And, the risk is for a lower-than-consensus print for the PCE Deflator, given that the February CPI was 0.2% (both Total and Core).  In this case, Real Consumption would be stronger if the 0.6% increase in Nominal Consumption prints. 

 

 

 

 

 

 

 

Eyes on The Consumer

The stock market could get some relief from February Retail Sales if consensus estimates are right.   Despite recent negative comments from retailers, consensus looks for +0.7% m/m Total and +0.5% Ex Auto.  This could be a weather-related rebound after declines in January (Total down 0.9% and Ex Auto down 0.4%).  Whether the health of the consumer is affirmed by this report could depend on how the January-February average stacks up against Q424 or how February's level compares to the January-February average.  The greater the improvement in either, the healthier the consumer.  If the retailers are right and retail sales fall again, the recession risk will get more play and hurt stocks.

Retailers blame fears of inflation and recession for the sudden consumer pullback they see.  These reasons appear to be confirmed by the University of Michigan Consumer Sentiment Survey.  The irony is that the latest data don't support these fears.  The February CPI and PPI showed that inflation remains near trend, if not slowing a bit.  And, Unemployment Claims indicate a still solid labor market.  Both Initial and Continuing Claims in February are within the low ranges seen since September-October. 

This would not be the first time the consumer pulled back sharply on questionable fears.  The consumer "went on strike" in 1980, reacting to misunderstood Credit Controls by the Carter Administration.  Many consumers apparently believed the Controls banned the use of credit cards, and they stopped spending as a  result.  The economy went into a steep dive that lasted two quarters.  Then, an ending of the Controls and lower interest rates led to a sharp rebound in spending and economic activity in the second half of the year.  

To be sure, there is a possibility that a sudden weakening in consumption has resulted from the stoppage of immigration.  Spending may have slowed as did population and employment growth.  This possibility raises the risk that the trends in consumption and the economy have ratcheted down. 

Trump's tariff actions and threats may continue to be a problem for the stock market.  They have been a mixture of temporary "transactional" moves to achieve an unrelated goal and more permanent revenue-producing tariffs.  The markets are never sure in which category a tariff announcement should be viewed, helping to explain the stock market's wild reactions.  The tariff problem should end for the market when the various countries decide to sit down together to settle the situation, just like what happened between the US and China in 2019-20.

There is a simplistic way of looking at tariffs that may shed light on Trump's actions.  Think of the economy as consisting of producers and consumers.  This is simplistic because everyone is a consumer.  Trump is aiming to help producers by protecting them from foreign competition.  But, he is downgrading consumers.  This split was articulated by Treasury Secretary Bessent, who said "access to cheap goods is not the essence of the American Dream."  Instead, he said "the American Dream is rooted in the concept that any citizen can achieve prosperity, upward mobility, and economic security."

With all this going on, it should not be surprising if this week's FOMC Meeting is a non-event, ratifying Fed Chair Powell's recent comments that monetary policy is on hold.  He will likely restate the policy restraint necessitated by the uncertainty surrounding Trump's policies.  The Central Tendency Forecasts will not likely change much from December, including the possibility of 1-2 rate cuts this year.

 

 

 

Focus On The Economy

The stock market may continue to be weighed down by uncertainty over Trump's tariff policies and their implications for growth and inflation.  Evidence so far points to slow economic growth in Q125  and a continuing downtrend in inflation -- not as bad as feared.  This week's releases of the February PPI and CPI could confirm the downtrend in inflation.

Consensus looks for +0.3% m/m  for both the February Total and Core CPI.  This would be down from 0.4% Total and 0.5% Core in January (start-of-year price hikes).  A 0.2% print for both cannot  be ruled out, even though last year February Core repeated January's high 0.4% print.  Airfares will not likely jump as they did in February 2024.  

Consensus also looks for 0.3% m/m for both February Total and Core PPI.  The Total would be down slightly from 0.4% in January.  Core would match its pace in January's as well as in February 2024, so the y/y should be steady at 2.2%.

The February Employment Report pointed to slow economic growth and low wage inflation.  While it did not completely shut the door on recession, it did not confirm one either.  There were signs of cautious behavior by companies rather than their "throwing in the towel" to brace for recession.

Some of February's +151k m/m Payroll gain was likely a weather-related rebound from January.  The 2-month average, which eliminates the weather effects, is +138k, consistent with a steady Unemployment Rate.  Indeed, the rebound in the Unemployment Rate to 4.1% from 4.0% in January puts it back to the Q424 average.  Although both Civilian Employment and Labor Force fell, the declines could be due to the small sample bias of the Household Survey. This bias is canceled out in the calculation of the Unemployment Rate, making the latter more significant than its components.  A steady q/q Unemployment Rate is not indicative of recession.

The one part of the Report that keeps the "recession" door open is the soft Total Hours Worked (THW).   Although they edged up m/m, they remained below the Q424 average.  The January-February average is 0.5% (annualized) below the Q424 average.  However, Q125 Real GDP Growth still could be positive once productivity is taken into account.  A low Nonfarm Workweek is responsible for the q/q decline in THW.  It suggests companies are responding cautiously to tariff uncertainty by working fewer hours rather than taking the more drastic action of cutting headcount.

There are signs in the Report that DOGE is reducing headcount in the Federal Government.  Jobs there fell 10k m/m (7k in Postal, 3k elsewhere).  The typical m/m change is +3k.

Some of the January-February Payroll slowdown could have resulted from labor shortages stemming from the drop in immigration.  If so, an increase in Job Openings is conceivable.  This week's release of JOLTS data will show Job Openings data for January.  However, it may be depressed by the bad weather and could be too early to see an impact from the drop in immigration.  

Perhaps reflecting a slower economy, wage inflation is back to looking tame.  The 0.3% m/m increase in Average Hourly Earnings in February, after a downward-revised 0.4% in January (was 0.5%), is below the recent 0.4% trend.  The February slowdown was widespread across sectors.

Besides the February Employment Report, there were other important data released last week:

1.  The decline in Initial Claims back to their recent low trend suggests the prior week's jump was related to faulty seasonal adjustment for the holiday.  A drop in Continuing Claims in next week's report would help to confirm this reason.  At this point, the labor market still looks solid.

 2.  Labor Compensation -- the broadest measure of labor costs -- were revised down sharply in both Q424 and Q324.  It now shows that Compensation/Hour rose only 3.8% q/q saar (was 4.2%) in Q424 and 1.3% (was 2.9%) in Q324.  The y/y is now reported as 4.0% in Q424 (same as the y/y for AHE in February) and 2.0% for Unit Labor Costs (which takes account of productivity growth).  The latter is in line with the Fed's 2% inflation target. 

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

Next Market Focus -- Trump Tariffs, CPI and Q424 Corporate Earnings

Stocks may continue to trade cautiously this week as Trump's inauguration (January 20) approaches.  So far, his policy pronouncements have not been market-friendly and the risk is they will stay that way.  There is a scenario, however, in which Trump's policies may be market positive, as discussed below.  The market also will be facing December inflation data and the start of Q424 corporate earnings.  Both are expected to be decent.  So, there could be relief bounces while the overall tone is cautious.

The market focus will likely be on Trump's decision regarding how to proceed with imposing tariffs.  For example, a 10% tariff on all US imported goods would amount to about $200 Bn for the year.  A 25% on goods imports from Canada and Mexico would amount to about $230 Bn.  A full pass-through to prices in either example would boost the PCE Deflator by about 1.0%.  This impact would be mitigated if importers absorb some of the tariffs by lowering profit margins.  Also, the stronger dollar is an offset.   

In any case, there may be silver lining for the markets.  Trump could tie the revenue from tariffs to an overall goal of holding down, if not reducing, the federal deficit.  To be sure, he will probably aim to extend the expiring tax cuts of his first Administration, but he'll also talk about cutting federal spending. 

Emphasizing the goal of reducing the federal deficit could spark a rally in the long end of the Treasury market and stocks.  A precedent is the Clinton Administration in the 1990s.  The then Treasury Secretary, Bob Rubin, always would mention deficit cutting in his speeches and press conferences -- which would induce a positive response in the bond market and stocks.  The federal budget went into surplus during the Clinton years, helped in part by huge inflows of capital gains taxes stemming from the stock market.

Consensus looks for 0.3% m/m Total and 0.2% Core CPI for December.  Even though gasoline prices fell at the pump in December, they did not fall as much as seasonal factors expect.  So gasoline prices (seasonally adjusted) should be up fairly sharply, boosting the Total.  A 0.2% Core may require Owners' Equivalent Rent remaining at a low 0.2 as well as Lodging Away From Home and Used Car Prices flattening after they jumped in November.  There is some evidence suggesting this may be the case for Used Car Prices.  The extent of holiday discounting is important, as well.  However, the greater the discounting, the greater the potential snap-back in January or February as normal pricing reasserts itself.

A benign 0.2% Core CPI should be a market positive, as it would suggest the strong labor market, as seen in Friday's December Employment Report, can be tolerated by the Fed in its fight against inflation.  The latter was suggested already by the downtick in December Average Hourly Earnings to 0.3%  from 0.4%.  However, a cautionary note is that long-term inflation expectations have moved up.  This is seen in Friday's report of 3.3% for University of Michigan's 5-Year Inflation Expectations measure,   It broke above its recent 3.0-3.1% trend.

Consensus estimate for Q424 S&P 500 earnings is in the high single-digit to low double digit range, better than the mid-single digit increase in Q324.  The macroeconomic evidence suggests some downside risk.  /1/ Profit margins may have narrowed, as wages sped up by more than prices.  /2/ Real GDP Growth is slightly lower in Q424 than Q324 on a y/y basis.   /3/ And, earnings from abroad should be hurt a little more by the stronger dollar and softer foreign economic growth.  In contrast, oil prices stopped falling (y/y), which should help that sector. 

                                                                                                                                        Markit
                                                                                                                                          Eurozone                        Real GDP     Oil Prices        Trade-Weighted Dollar    AHE     Core CPI    PMI  
                [                                y/y percent change                                                   ]    (level) 

Q123            2.3                -19.5                +3.0                              4.5           5.5               47.9  

Q223            2.8                -32.0                 +0.5                              4.4           5.2               44.7

Q323            3.2                -12.0                 -2.5                               4.3           4.4               43.2

Q423            3.2                -12.0                 -2.5                               4.3           3.9               43.8

 

Q124            2.9                +14.0                  0.0                              4.3           3.8               46.4

 

Q224            3.0                  +2.5                +3.0                              3.9           3.4               46.3 

 

Q324            2.7                  -6.0                 +2.5                              3.8           3.2               45.3     

 

Q424            2.6                   0.0                 +3.5                              4.0           3.3               45.4                             

                                                                           

* Based on the Atlanta Fed Model's latest projection of 2.7% for Q424 (q/q, saar).

Upcoming Macroeconomic Data Market Friendly?

The stock market may very well move move up in the next week or two, as the macroeconomic data are expected to be market friendly.  The key data are seen showing moderate growth and inflation, a good combination now that the Fed is likely to be on hold for awhile.  Market caution may reassert itself as the Presidential inauguration on January 20 gets closer.

Consensus expects a near-trend December Employment Report.  Nonfarm Payrolls are seen rising 150k m/m and the Unemployment Rate steady at 4.2%.  A near-consensus increase would be between the 3-month average ( 173k) and the October-November average (132k).  (Note that October and November were impacted by strikes and bad weather, which should be cancelled out when the two months' jobs gains are averaged.)  An uptick in the Unemployment Rate can't be ruled out, as the Rate rounded down from 4.245% in November -- "noise" in the data could push the headline print up to 4.3%.  Consensus looks for a return to 0.3% m/m in Average Hourly Earnings.  This would be a favorable print for the markets and Fed, after AHE averaged 0.4% in the prior 4 months.

The November JOLTS data are expected by consensus to show a dip in Job Openings, with the Total being close to pre-pandemic levels.  A dip would indicate some softening in demand for labor.  It will be interesting to see if Hires soften, as well.  Continuing Unemployment Claims have hinted as such in recent weeks, adjusting roughly for holiday effects.

Last week's release of the December Mfg ISM offered evidence of moderate economic growth.  The 49.3 print is in line with a gradual (albeit uneven) improving trend since July.  It exceeded both the Q424 average (48.1) and the Q324 average (47.1).  This kind of gradual improvement should be market friendly (for both stocks and bonds), assuming the Fed is on hold.  Moderate growth is good for the profit outlook while still being non-inflationary.  The Mfg ISM Survey results do not call for tighter monetary policy. 

Indeed, the Atlanta Fed model's latest estimate of Q424 Real GDP Growth is 2.4% (q/q, saar), which, if correct, should keep Fed's policy intentions unchanged -- that is, keeping open the door for modest easing next year.  This pace is just above the longer-term trend estimated by the Fed.  It would put the 2024 (Q4/Q4) growth rate at 2.5%, matching the Fed's Central Tendency Forecast.  It should give the Fed more confidence in its forecast of 1.8-2.2% in 2025.