Updates

A potentially very expensive summer…

• Earlier today, the Senate passed its version of President Trump’s so-called “Big, Beautiful Bill” before the self-imposed July 4 deadline. The path forward remains rocky as the Senate bill is projected to increase the U.S. deficit by more than $3.3 trillion over the next 10 years. This proposed deficit increase flies in the face of prior Administration promises to reduce debt in previous tax bills. Yet to be seen is whether the House will approve this version of the bill which is even more expensive than the version it previously approved several weeks ago.

• When coupled with an already large structural deficit of almost 7% last year during a period of economic expansion, many analysts consider the proposed bill to be severely detrimental to the country’s long-term finances. The trillion-dollar question is whether enough House Republicans will go along with the revised bill or whether there remain enough fiscal conservatives to choose to follow a more prudent fiscal path. The Administration continues to target having a final approved bill from Congress for presidential signature by this Friday.

• Looking to the markets, in the just completed quarter, a sharp market selloff, driven by President Trump’s new tariff regime, ended with a significant market rebound. The S&P 500 and the Russell 1000 Value both closed out June at, or near, highs for the first time since February and clocked some of their strongest quarterly gains since early 2024.

• Meanwhile, last Friday the Fed’s preferred monthly inflation measurement was released – the Personal Consumption Expenditures index (PCE) which rose 0.1% month over month with its reading of 2.3% annualized growth. Meanwhile Core PCE was 0.1% higher than expected at 2.7%, exceeding expectations for a 2.6% print.

• As it feels its way forward regarding interest rates, the Federal Reserve is keeping a keen eye on employment. One piece of data that is likely of interest is that the unemployment rate for recent college graduates continues to rise-now up to 5.8% through the month of March. Outside of the COVID era, this is the highest unemployment rate for these recent graduates since 2012. Economist are starting to call this economy a “no hire, no fire economy.” We will need to wait and see how the central bank and Chair Powell continue to assess, and act, on this data at their July-end meeting. 

The Pressure for Rate Cuts is Increasing…

• Despite war raging in the Middle East and Europe, domestic protests across the country, and volatile tariff policies, American markets continue to move higher. The S & P 500 and the Russell 1000 Value indices are now positive on the year with Treasuries continuing to trade in a tight range.

• Clearly, the markets are in a “risk on” mode as they have largely ignored the intensifying war between Iran and Israel. While it appears to be unlikely, the chance of an expansion of the current conflict cannot be totally ignored.

• The Federal Open Market Committee (FOMC), the group that determines the Fed’s overnight lending rate, will begin its fourth meeting of the year this week. The market, along with most investors, believes the committee will leave rates unchanged. Currently, the Street is still pricing in one, if not two, quarter point cuts before the end of the year. With most recent economic data being relatively benign, the chorus is getting louder for the Fed to cut rates with recent inflation reports coming at, or below, expectations.

• Meanwhile, employment numbers have largely held steady. Consumer sentiment has declined appreciably year to date largely due to the changing tariff environment although it showed a modest increase in the latest reading. Adding to the pressure to cut rate are the persistent and vocal demands from the Administration for interest rates to come down. However, the evolving tariff and trade landscape has made Chairman Powell and other FOMC members more hawkish, which could prolong the amount of time before more cuts occur.

• It is expected that President Trump will not reappoint Jerome Powell for another term as Federal Chair. Currently, projections suggest that Treasury Secretary Bessent is likely to be nominated instead. As Powell’s term nears its end, there are concerns that Chair Powell may become a lame duck with little influence and authority in shaping policy decisions.

Tariff uncertainty continues to have economic ripple effects…

• Tariff headlines continue to dominate the news and is strongly influencing not only the US economy but that of the world. Last week, the Bureau of Economic Analysis confirmed the drop in GDP for the first quarter of 2025 to an annualized decline of 0.2%, slightly better than the -0.3% expected. The contraction was due to a sharp increase in imports as many businesses brought forward overseas purchases in an attempt to avoid some of the new pending tariffs. 

• One of the more important data points found in the latest GDP report was that consumer spending grew at a very modest rate of 1.2% annually. This is the lowest increase in three years, down significantly from the 4.0% growth rate in Q4 2024. The diminished consumer buying was a poor economic sign as the American shopper represents more than two thirds of the nation’s economic activity.

• The PCE index, i.e., the Fed’s preferred inflation gauge, was reported last week and showed an annual growth rate of 2.1%, beating the 2.2% expectations. Core PCE reported a growth rate of 2.5%, also beating expectations of 2.6%. Both numbers continue a drift down towards the Fed’s goal of 2%. Whether this will be sustained in the face of the Administration’s erratic tariff policy is yet to be seen. As a result, the markets continue to price in at least two rate cuts before the year-end.

• The Fed Chair and his team have been reluctant to reduce rates so far this year for fear of stagflation, largely due to economic uncertainty created by the Administration’s new tariff stance. Policy setting members so far have agreed that the high economic uncertainty coupled with the increased risk of higher unemployment and inflation warrants a wait and see approach. In a recent meeting with President Trump, Fed Chair Powell reportedly maintained his stance that central bankers will make interest rate decisions based solely upon “careful, objective and non-political analysis.”  How the potential disagreement between the Fed and the new Administration is resolved remains to be seen.

And another pivot in U.S. tariff policy…

• Over the weekend, the United States and China jointly declared a 90-day suspension of their new tariffs of 145% and 125%, respectively. During this interim period, U.S. tariffs on Chinese goods will be 30% – a sharply higher amount than two months ago but at a level that does not effectively fully embargo Chinese goods as the 145% rate did. Trade negotiations will continue during this 90-day period in an attempt to devise a more permanent solution.

• This announcement came on the heels of a tentative American and England trade deal announced last week. In this agreement, the two countries announced a limited bilateral trade agreement that leaves in place the President’s 10% tariffs on British exports while modestly expanding agricultural access for both countries and lowers high U.S. duties on British car exports.

• The stock markets reacted very positively to the two new tariff agreements with a broad rally across all major indexes and sectors – even though these agreements are only temporary in nature. Clearly, expectations were for even worse outcomes as these new agreements still represent sharp increases in U.S. import taxes. The technology sector, previously among the hardest hit, has seen especially strong gains. Despite the sharp sell-off in April, the recent surge has pushed the S&P 500 back near its starting level for the year of 5,800.

• In other news, the Federal Reserve held rates steady at its latest meeting. At the subsequent press conference, Chair Powell expressed concern over the economic impact of the new/ever changing tariff policy. Earlier today, April’s core CPI was released showing a 2.8% rise in prices, consistent with expectations; the April Producer Price Index is to be released on Thursday with both figures anticipated to register in the high 2% range. These readings will be closely watched by investors and policymakers as they will influence the Federal Reserve’s interest rate stance and shape expectations for the broader economic outlook.

The way ahead grows cloudier…

• Earlier today, good news was reported as March’s inflation dropped to an annualized rate of 2.3% as measured by the Fed’s preferred inflation gauge – the PCE Index. The reading slightly missed the expected figure of 2.2% while core inflation met expectations of 2.6%. The signs, for the moment, show inflation is slowly creeping back to the Fed’s goal of 2%. However, the likelihood of achieving this goal has grown cloudier as current expectations for future inflation keep rising, largely due to the impact of the Administration’s new tariff policies.

• As expected, bad news came from the 1^st quarter’s GDP growth when the Commerce Department reported the economy contracted at an annualized rate of 0.3%, the largest decline in economic activity since the first quarter of 2022. Economists surveyed by the Wall Street Journal had predicted a more subdued growth rate of 0.4% rather than reported decline. One of the first major economic reports of the Trump presidency, many consumers and business leaders pointed to the inconsistent tariff policy as reasons for their more cautious investment and spending decisions.

• ADP’s latest employment report revealed a significant slowdown in hiring with just 62,000 jobs added in April compared to 147,000 in March. An ADP economist cited growing business unease, amid ongoing economic turbulence and uncertainty, making it increasingly difficult for employers to plan for greater jobs creation. Despite the slowdown, the ADP report did note that layoffs have not yet seen a substantial increase.

• With the earnings season well under way, reported corporate earnings show earnings per share (EPS) growth of 10.1% year-over-year, the second consecutive quarter of double-digit growth. Looking ahead, many companies have issued more cautious outlooks, warning of reduced revenue and shrinking profits amid a now highly uncertain political and economic climate. A number of major firms have unusually suspended providing earnings outlooks for this fiscal year, citing the uncertain impact of the new tariff policy.

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.