Updates

Tariff uncertainty increases the likelihood of higher for longer…

• The Fed held its second rate setting meeting of the year last week. To the surprise of no one, the committee held steady on rates and elected to take no action citing economic uncertainty due to tariffs, taxes, immigration, and the many other changes being instituted by the new Administration.

• One of the biggest takeaways from the Fed meeting was the committee increasing its year-end inflation estimates to 2.7% from 2.5%. Further, the committee lowered its 2025 economic growth estimate from 2.1% to 1.7%. If the Fed’s predictions turn out to be accurate, investors could have increasing reason to fear stagflation. Stubborn Inflation paired with low to little growth is the very definition of stagflation. In recent days, one central banker, Raphael Bostic, has already stated his belief that no more than one rate cut will be necessary this year.

• After spending weeks talking up sharply higher trade tariffs, the Administration in recent days has begun to walk back some of these pending tariffs. Expectations now are that President Trump will probably exclude a range of industry-specific tariffs while imposing reciprocal duties on a select group of countries that make up the majority of U.S. foreign trade. Although sector-specific tariffs are not likely to be announced on April 2, there are still plans to unveil reciprocal tariff actions then. The entire tariff structure and timing for Canada and Mexico remain uncertain as well with modifications announced by the Administration almost daily.

• Lastly, this week is chock-full of economic data releases. Revised GDP data for 2024 Q4 will be announced on Thursday; expectations are for 2.3% annual growth rate. Friday, the Fed’s preferred inflation measure, the PCE index, will be released with expectations for both the regular and core PCE indexes to increase 0.3% month over month. With the regular PCE expected to increase 2.5% annually, and the core PCE to increase 2.6%. Additionally, the Bloomberg Economic Survey and the University of Michigan Consumer Sentiment surveys will be released this week. These readings have become key data points for the Fed – offering valuable insights into consumer behavior in the current economic climate.

Buckle up, the ride is just getting started…

• Fears have been growing that the U.S. economy is headed for one of two possible outcomes: stagflation or recession. The Alanta Fed recently forecasted that an economic contraction would take place in the first quarter of 2025 with an annualized GDP decline of 2.8%. President Trump attempted to downplay these fears over the weekend stating “I hate to predict things like that. There is a period of transition because what we’re doing is very big. We’re bringing wealth back to America. That’s a big thing, it takes a little time, but it should be great for us.” Most analysts took his comments to indicate an indifference on the Administration’s part as to whether the economy was to shrink while the president is enacting his desired changes to government.

• To date, the Trump Administration has implemented the following tariffs: 20% on all imports from China, up to 25%+ tariffs on Mexican imports and most Canadian imports although there is a one-month exemption for the automotive industry. Lastly, a 25% tariff on all aluminum and steel imports was just enacted. And even this data is stale as this Tuesday morning, the Administration increased steel and aluminum tariffs on Canada to 50% in partial retaliation for Canada’s response to the implementation of the first set of new American tariffs.

• All of these policy shifts are sowing havoc for business. U.S. economic data has begun to reflect the enormous changes now being implemented by the new Administration. The most recent unemployment rate of 4.1% was released last Friday, slightly exceeding economist expectations of 4.0%; however, these figures did not include the wave of work force reductions being implemented on Federal employees. The figure contains neither the roughly 75,000 government workers who accepted the “deferred resignation” offer nor the approximate 200,000 (and counting) Federal jobs eliminated year-to-date.

• Due to the whipsawing changes to trade policy, companies are struggling to adapt to the rapidly changing global markets. With this substantial uncertainty, there has been a sharp increase in capital markets volatility. Specifically, the equity markets have seen a significant sell off with the S&P 500 and Nasdaq both down over 5% in the last week and with the Nasdaq down an even more severe 12% in the last month. The market’s fear gauge meanwhile has climbed over 70% in the last week – going from a below average volatility reading to its current reading reflecting expectations of near-term volatility sharply above normal. Yes, it is time to keep those seatbelts on and tight.

And market volatility shows an increase…

• Markets finished last week in a volatile fashion, erasing most of the week’s gains with all three major indexes closing down at least 1% on Friday. The Dow Jones and S & P 500 both experienced their biggest one day drop this calendar year, with both indexes closing the day down 1.7%.  Largely fueled by poor economic data reported throughout the week. Further adding fuel to the fire on Friday was the bombshell report that the Justice Department was investigating United Healthcare, the largest private health insurer, for its Medicare billing practices.

• Last Wednesday the Fed released their minutes from its January meeting, and the minutes largely reflected what the central bankers have been saying publicly. Echoing the uncertainty on policies surrounding trade and immigration, the Federal Open Market Committee (FOMC) members have opted for a wait-and-see approach on future rate decisions. The Fed is in no rush to lower, nor raise rates at this point in time. The Fed’s ideal rate remains the same – one that keeps unemployment at a healthy level while continuing to reduce inflation to its 2% target.

• The Wall Street Journal published a report over the weekend detailing the changing consumer profile. The study showed the top 10% of earners, households who make roughly $250,000 or more a year, account for 49.7% of all U.S. consumer spending. Further, the report indicated that this cohort of households account for almost one-third of overall U.S. GDP. In short, the financial situation of the wealthy has never been stronger, their spending is all-time highs, and the economy is more reliant on this group than ever before.

• At the end of this week, the Fed’s preferred inflation measure, the PCE Index, will be released. Expectations are that the year-over-year inflation will have increased by 2.6%. If expectations are accurate, this would represent a small reduction from last month’s annual figure of 2.8%. With looming tariffs, and other inflationary policies being pursued by the new Administration, the Fed will be putting more attention on this vital measure of inflation.

What will move the Fed out of its current wait and see stance?

• Earlier today, the U.S.’s Bureau of Labor Statistics released hotter than expected CPI data – confirming investors’ anxiety regarding too-hot inflation that is likely to keep the Fed on the sidelines for the immediate future. January’s consumer price index jumped 0.5% for the month, putting the annual inflation rate at 3%. Both were more than the 0.3% and 2.9% increases expected by economists polled by Dow Jones. Excluding volatile food and energy prices, the core CPI rose 0.4% on the month and 3.3% for the past 12 months, again both higher than expected.

• Meanwhile, the Labor Department’s last Friday jobs data was more encouraging as the unemployment rate beat expectations and declined to 4.0% last month. Experts expected the economy to add 169,000 jobs in January although only 143,000 positions were added; this represented a drop in jobs creation even relative to the November and December data. However, the year-end 2024 job market was much stronger than previously thought. Jobs estimates for November and December were revised upwards a total of 100,000 positions.

• How does the strong job’s data impact the Fed? The January jobs report is unlikely to cause Powell and other senior Fed officials to alter their current wait-and-see approach to interest rate cuts. The U.S. central bank remains focused on ensuring inflation continues to its gradual decline toward its 2.0% target. To date, it has expressed little concern that the labor market is driving inflationary pressures nor that it is foreshadowing recession – certainly, a goldilocks moment. However, today’s inflation report combined with the “just right” jobs data almost guarantees the Fed will hold off of any near-term moves.

• Current predictions show only a 30% likelihood of a rate increase by mid-June. However, some large unknowns such as U.S. tariff policies could quickly change current expectations. Of particular concern to inflation hawks, President Trump announced his intention to place 25% tariffs on imports of steel and aluminum to the U.S., levying this fee even on the U.S.’s closest of allies such as Canada, Mexico, Japan, and South Korea. This position is more extreme that the tariff posture taken during the first Trump Administration where businesses could file for exclusions from a given tariff. If actually implemented, these taxes on imports to the U.S. could cause appreciable inflation in America – exactly what the Federal Reserve has spent the last 2+ years fighting against.

Fed stands pat to no one’s surprise….

• Fed Chair Powell held his first press conference of 2025 today. To the surprise of no one, the central bank took no action on interest rates. However, what was more important about today’s announcement was the commentary. Powell’s disposition and language favored neither a dovish nor hawkish position. According to the Fed Chair, although hiring has slowed, the labor market remains in a good position as is also the economy. Inflation is yet to achieve the target of 2%, but it continues to make progress. Powell emphasized that the Fed would continue to be data dependent and not let outside parties, i.e., implying the White House, pressure the committee on future rate decisions.

• President Trump returned to the White House last week and once again smartphones are actively buzzing with new breaking news. One of the Administration’s most significant proposals is a sharp increase on many imported goods. If enacted, this move would almost certainly help reignite inflation – the very thing that the U.S.’s central bank has spent the last two years trying to tame. However, so far 2025 is off to a good start with December inflation figures beating expectations as the readings came lower than originally forecasted. However, inflation data is a lagging economic measure. As a result, any inflationary effects from actions of the new Trump Administration are unlikely to be seen before this summer, at the earliest.

• Looking to the financial markets, the recent release of China’s DeepSeek AI caused sharp declines in all AI and AI related stocks on Monday. To the dismay of semiconductor companies like Nvidia, Broadcom, and others, the Chinse AI firm claims that its product operates at a fraction of the cost of its rivals. If these claims prove true, there could be sharply lower demand for advanced chips and the many products and services associated with the nascent AI industry.

• Of concern for stock investors, the equity risk premium recently turned negative. Defined as the difference between the corporate earnings yield and the yield of the 10-year Treasury, the differential between the two figures indicates how much investors are compensated for the greater risk of owning stocks over risk-free government bonds. Given their risk profiles, over the long-term stocks should provide a higher return than risk-free bonds. In recent days, however, there has been no additional premium to hold stocks over bonds – a concerning assessment regarding the valuation of the current stock market. As a result, Wall Street is lacking critical support for meaningful sustained additional advances. However, as we have discussed previously, the “animal spirits” can drive markets upwards for quite a while although underlying fundamentals can be weak.

2024 Year Wrap Up…

•U.S. equity markets recorded another banner year and proved their resiliency once again.  Led by the Magnificent 7 tech stocks, the S&P 500 finished the year with a 25% gain as the Russell 1000 Value advanced a robust 14%. The Russell 2000, which focuses on small cap companies and is considered a more accurate barometer for the local economy, finished the year with a 10% gain.  Ten of the eleven equity sectors finished positive, with the majority having double digit returns.

•In looking overseas, European equity markets performance was largely a mixed bag. The Germany markets led the way with a 19% gain while France’s CAC 40 was a substantial laggard with a 2% loss, largely on the back of ongoing political turmoil and fiscal deficit issues. Looking further east, Asian markets had strong performances, all finished the year up double digits, led by Japanese market’s 20% gain on the year.

•Reviewing rates, the Fed’s overnight lending rate finished the year in a range of 4.25-4.50% thanks to three rate cuts in the latter part of the year. The U.S. Treasury 10-year rate finished the year at a relatively elevated level of 4.53%, substantially higher than the sub 4% rate found at the beginning of the year. Throughout 2024, the Treasury yield curve largely flattened – going from being an inverted yield to a more traditional rising curve, albeit remaining fairly flat. One area of the fixed income asset class that struggled was long dated bonds which felt the biggest effects of a rising 10-year Treasury yield.

•Looking at commodities, they had quite the roller coaster of a year across the asset class. Gold and silver had a banner year, finishing at all-time highs, largely fueled by speculation and their appeal as asset safe havens. Oil struggled last year, with Brent and WTI finishing the year negative. But, while oil struggled, natural gas finally finished the year with a 50% gain. Overall, an interesting year, to say the least!

After today’s rate cut, is the Fed ready to pause?

• Chair Powell and the FOMC had their final meeting of the year today and announced a 0.25 percentage point cut to the overnight borrowing rate. In addition to the rate announcement, Chair Powell provided guidance to the Fed’s interest rate path moving forward. He stated that the Fed now expects two rate cuts in the next year which was an appreciable downward adjustment from prior expectations of four potential cuts. The markets were not receptive of this news and sold off.

• It is largely believed that the Fed made the additional cut because of the cooling labor market – while layoffs are not increasing, neither is hiring. The unemployment rate began the year at 3.7% and has slowly increased over the year to 4.2%. The rate cut comes despite the prolonged battle against inflation, and growing fears that Trump policies could be inflationary. Last week, the most popular inflation readings, CPI and PPI, released their monthly figures for November. The Consumer Price Index (CPI) largely met expectations, but the core CPI figure continues to hover above the 3% mark. The Producers Price Index (PPI) posted a 3% annual increase, the largest annual increase since February 2023. With several inflation readings remaining appreciably above the Fed’s target of 2%, the argument for continued appreciable rate cuts is becoming more tenuous.

• A number of important economic releases occur this week and they will have a significant impact as we enter 2025. Manufacturing data released on Monday signaled that U.S. factories are experiencing their highest level of activity in nearly three years. Tuesday, U.S. Retail had a month over month gain that beat expectations and showed the resiliency of the U.S. consumer. Today, Wednesday, housing data released was a mixed bag with a decline in housing starts but a significant increase in single family housing starts and building permits. On Thursday, additional housing data will be released along with jobless claims. Finally on Friday, to cap off the week, the Fed’s preferred inflation gauge, the personal consumption expenditure (PCE) figure will be released. Expectations are that it will indicate a 2.8% annual increase in prices for November, an appreciable increase over October’s annual reading of 2.3%.

Higher for longer after all…

• Equity markets participants showed their approval of the re-election of President Trump as the markets surged to record highs in the following days.  Further adding to market sentiment was Fed Chair Powell’s announcement of a quarter percentage point cut to the overnight lending rate. Some of the initial post-election market enthusiasm faded as global geopolitical risks escalated. International tensions escalated following the U.S. authorization for the Ukraine to attack Russian territory of Ukraine’s with American supplied long-range missiles. Somewhat counterintuitively, long-term interest rates have surged in recent days to 6-month highs on growing fears that Trump Administration policies could reignite inflationary pressures.

• The Fed’s chair stated that “the economy is not sending any signals that we need to be in a hurry to lower rates. The strength we are currently seeing in the economy gives us the ability to approach our decisions carefully.”  On the back of these announcements, experts reduced the likelihood of a December rate cut to 60% from prior expectations of an 80% likelihood. Additionally, traders have reduced expectations of rate cuts by 1 percentage point with forecasts now anticipating overnight rates of 3.9% by year-end 2026 rather than prior forecasts of 2.9%

• On the inflation front, last week’s Consumer Price Index (CPI) and Producers Price Index (PPI) data were released with both figures meeting expectations. The CPI showed an annual increase of 3.3% with more than half of the gain being attributed to housing costs. The PPI print came in at 2.4% – a stark increase from the previous month of 1.9%. Both figures, echoing Chair Powell’s commentary, indicated that there are some inflationary components that remain elevated and may be taking longer than previously anticipated to decline to more acceptable levels.

Presidential Election & Federal Reserve meeting have market anxious…

• The Presidential election is finally here, and the race remains a dead heat with pollsters saying the race is a coin toss. Given how close the race is, a winner is not anticipated to be known for days. However, investors have been trying to position their portfolios based upon their expected winner. With the race being so close, this is likely a fool’s errand.
• The leaders of the US central bank are set to meet this week, their second to last meeting for the year. Currently, the market is predicting a near certainty, a 98% chance, for a quarter percentage point rate cut thus reducing overnight interest rates to a range of 4.50%-4.75% from its current range of 4.75%-5.00%. Overall, economic activity remains promising.

• The latest GDP readings had the economy has growing by a 2.8% annualized rate of growth over the last quarter. Inflation has continued to decline with the latest PCE reading in September of 2.1%, almost achieving the Fed’s 2% goal. On the downside, employment reports for August and September were revised lower, and payroll growth in October is expected to be much weaker, emphasizing that wage growth is cooling. A primary contributor to the negative payroll/jobs data has been the ongoing Boeing strike which was just resolved this morning.

• Meanwhile, equity markets continue their ascent on the back of modest 3^rd quarter earnings growth while bond markets have proven to be more volatile. The US Treasury 10-year yield, the benchmark for the corporate bond market, has risen 18% in the last two months to 4.30%. This is a result of the bond market anticipating slower and fewer rate cuts than what the Federal reserve anticipated and concerns over the inflationary impact of the proposed policies of the two presidential candidates. Expectations are for elevated volatility in coming weeks as additional clarity on the incoming presidential Administration and the Fed’s direction is found.

Hot jobs markets surprises many…

• The Department of Labor released its September jobs report on Friday containing a number of surprises. The Street expected the unemployment rate to stay at its most recent 4.2% level, and instead the reading came in lower at 4.1%. Further, employers added 254,000 new positions in September which was 40%+, or 100,000 more, than economists had anticipated.  Lastly, the report revised data from prior summer months to show that employers actually created an additional 72,000 more jobs than initially reported.

• Until this jobs report was released, investors were predicting that the Federal Reserve would cut the Fed Funds rate by a total of 1.25 percentage points before year end. Given the 0.50 percentage point rate cut last month, expectations for further rate cuts before year-end were high. As a result of this jobs report, analysts are now expecting much less aggressive action by the Fed’s rate setting committee. Partially as a result, the benchmark 10-Year Treasury rate has climbed almost 10% within the last month, to ~4.0%, a dramatic increase in an otherwise falling rate.

• Last week, the U.S. Bureau of Economic Analysis also released an upward revised final estimate of the 2^nd quarter U.S. GDP which showed an annual growth rate of 3.0%. In comparison, the year’ first quarter had a more tepid growth rate of 1.6%. With the more robust economic growth combined with the impressive jobs report, the economy is clearly better positioned than many had believed.  

• In addition to early earnings reports from several bellwether companies, this week will also have the latest update on the nation’s Consumer Price Index (CPI) and Producer Price Index (PPI), the two most popular inflation readings. Investors are expecting both numbers to continue their gradual descent, with the CPI reading expected to have an annual 2.3% rate increase and the PPI expected to print a 1.7% increase year over year growth rate. If these numbers are achieved, the markets will happily absorb this positive data.