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.