New Tariff Regime May Not Change Picture

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

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

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

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

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

 

 

 

 

 

 

 

 

 

 

 

 

  

Little Change in Macroeconomic Background

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

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

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

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

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

 

 

 

 

 

 

  

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

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

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

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

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

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

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

                                       Private Payrolls (m/m change, 000s)   

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

    March               155                          209                            120

    April                   62                          167                            133                               14                            

    May                    37                          140                              69                              -74           

    Jun                    -33                            74                             -27                              -57                              

    Jul                    104                            83                               77                               18   

   Aug                     54                            38                               -4                                 2                            

   Sep                    -32                           119                              104                             28 

   Oct                     42                             na                                  1                             -41 

   Nov                   -32                            69                                50                               14

    Dec                   41                            37                                 na                               30     

    Jan 26               22                            na                                 na                               86                                    

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

                             (q/q percent change)

                            AHE                ECI 

Q425                    1.0                    

Q325                    0.9                    0.8

Q225                    0.8                    0.9

Q125                    1.0                    0.9                             

 

Two Market-Important Developments

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

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

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

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

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

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

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