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.
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