Spring Rally?

The stock market may continue to move up, now that Trump appears to have pulled back from undermining Fed Chair Powell and Treasury Secretary Bessent suggested the trade war with China will de-escalate soon.  Besides keeping an eye on whether these shifts in fact occur, stocks are likely to re-focus on the US economy.  Evidence of moderate or strong growth and low inflation will be positive, as it would suggest the economy could avoid recession after the tariffs hit.

This week's key US economic data should not stand in the way of further stock market gains.  Despite an expected a flattish Q125 Real GDP and modest April Employment Report, the latter's details would point to a speedup in Q225 Real GDP Growth.  And, inflation-related data are expected to be subdued. 

Q125 Real GDP is expected to be soft.  Consensus looks for a slowdown to +0.4% (q/q, saar) from 2.3% in Q424 while the Atlanta Fed Model projects -0.4% (ignoring its -2.5% projection that incorrectly includes the impact of gold imports).  There are several possible reasons for a slowdown:  /1/ Bad weather in January and February whose impact was not fully offset in March, /2/ Lagged drag from the tight level of monetary policy, /3/ cautious behavior of consumers and businesses ahead of Trump's tariffs and government firings, and /4/ drag from the stoppage of illegal immigration.  The first explanation is the one with the most potential to reverse in Q225.    

If Q125 Real GDP surprises on the upside, the market may quickly discount the strength if it stems from a jump in inventory investment.  The latter would be viewed as temporary.  However, the inventory buildup most likely would consist of imports brought into the country ahead of tariffs.  So, any unwinding of inventory investment in Q225 would probably be matched by an unwinding of imports -- with little net impact on GDP.   

The April Employment Report will offer a picture of the economy's strength in early Q225.  If consensus is right, the jobs report should point to a speedup in Q225 Real GDP Growth. 

Payrolls are expected to be on the soft side, however.  Consensus looks for them to climb 130k m/m, after a post-winter bounce of +228k in March.  Payrolls averaged 152k m/m in Q125 and 168k m/m in 2024.  Despite the expected slowdown in job growth, the Unemployment Rate is seen remaining at 4.2% and the Nonfarm Workweek flat at 34.2 Hours.  If consensus prints, and there are no revisions to prior months, Total Hours Worked in April would stand 1.5% (annualized) above the Q125 average.  THW rose 0.5% (q/q, saar) in Q125.  So, THW would point to a speedup in Q225 Real GDP Growth. 

Other key US economic data this week could temper expectations of the magnitude of a speedup, based on consensus estimates.  Consensus looks for a dip in the Mfg ISM to 47.9 in April from 49.0 in March and 50.1 in Q125.  It would be the second consecutive m/m decline, but remain at a non-recessionary level.  Hard data on manufacturing indicated modest growth in March.  

This week's inflation-related data are expected to be subdued.   Consensus sees April Average Hourly Earnings contained at a modest 0.3% m/m.   The Q125 Employment Cost Index (ECI)  is seen rising 0.9% q/q, the same as in Q424.   Both Average Hourly Earnings and the ECI have had a fairly steady pace recently (see table).  The y/y for both is just under 4.0%, consistent with 2.0% price inflation if underlying productivity growth is about 2.0%.  

Consensus looks for a slight  0.1% m/m increase in the March Core PCE Deflator, in line with the low Core CPI print.  Note, however, tariffs on Chinese goods are already hitting consumer prices in the US, according to news reports.  Their impact will presumably be seen in the April and May CPI.

                             (q/q percent change)

                          AHE                        ECI 

Q125                0.9                            na

Q424                1.0                           0.9                                                

Q324                0.9                           0.8    

Q224                1.0                           0.9                     

Q124                1.0                           1.2                     

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.