No one asked me, but if I had to rank the top 3 reasons why Trump beat Biden, it would be (in no particular order)
- Inflation
- Inflation
- Inflation
Save yourself the time and don’t bother emailing me about the socialist agenda or gender identity overreach. Those were amplified because Americans were buckling under surging costs of everything. The Biden administration kept trying to tell Americans that inflation wasn’t a problem anymore, but real Americans don’t talk about inflation in terms of y/y increase. Instead, they think of it in terms of absolute cost. Here’s a Starbucks cup of coffee.
“See! Starbucks Inflation is 0%...you’re welcome,” Joe Biden circa June ’24.
“Yeah, but it’s still $1.18 more than a couple of years ago, so what do I care that it didn’t keep going up? That’s 25% more for the same cup of coffee. Oh, and I can’t afford Starbucks anyway, but thanks.”
Won’t these tariffs lead to similar frustration? The Fed described the impact on prices as a one time increase, but a year from now it still costs 25% more than it did today. That, in turn, makes people cranky and they take it out on the politicians responsible for it.
That’s why economists are scrambling to revise GDP forecasts so dramatically. I’ve been beating the drum that inflation is only step 1 of tariffs, complaining that so few seem to consider the rest of the effects. Shifting spending habits, product substitution, and oh yeah…a trade war. China retaliated and we are off to the races.
Keep in mind that tariffs were enacted with the single stroke of a pen and they can be undone just as quickly. I don’t think the T10 will surge to 4.5% on tariff good news, but it’s not off the table, either.
Last Week This Morning
- 10T: 4.00%
- 2T: 3.65%
- SOFR: 4.39%
- Term SOFR: 4.32%
- Nonfarm Payrolls: 228k actual vs 140k expected
- Trump’s reciprocal tariffs outpaced all expectations
- Fed Speeches:
- Jefferson: "In my view, there is no need to be in a hurry to make further policy rate adjustments”
- Cook: “I am watching for evidence of trouble on longer-term inflation expectations.”
- Kugler: “There may be reasons why tariffs have more prolonged effects” as tariffs “will affect all sectors through supply chain networks...It may take longer for that to filter through the economy”.
- Chair Powell: "It feels like we don't need to be in a hurry (to cut rates)...Inflation is going to be moving up and growth is going to be slowing."
Google Searches for Smoot Hawley
Rates
I told you 3.99% was a key resistance level and guess where we closed on Friday? Magic.
Somewhere around 3.89%-3.92% is the next stop. It’s not surprising we rebounded above that level after NFP surprised to the upside, but that was only worth 10bps. With the trade war just starting, it will probably take really good news on the tariff front to lead to the T10 running back up to 4.25%.
Downside: 3.89% and then 3.62% (this is the most important level – it served as a ceiling for literally 10 years)Upside: 4.12% and then 4.35%
My position heading into 2025 was at least 75bps of cuts, largely based in a belief the economy would weaken. And that was before tariffs and DOGE, which stand to exceed my wildest expectations for a slowdown. Paradoxically, I am actually less confident in those cuts by year end. Why?
The Fed cannot lose the war on inflation. The hit to its credibility and the ripple effects from that are too severe. The tariffs will be inflationary, even if only temporarily.
That suggests the Fed will be on hold for longer than expected. The Fed will tolerate negative/anemic growth. It will tolerate an equities sell off. Slower consumer spending. The Fed will tolerate a lot of economic pain while it waits to see how inflation plays out.
The market has a 95% chance of a cut in June…I think that’s insanity. I don’t think the wheels can fall off fast enough for that to happen. In fact, I think the magnitude of these tariffs force the Fed to be on hold longer than they would like.
I still believe in at least 75bps this year, but any cuts are more likely to be back end loaded – and that means they could bleed into next year. The economic slowdown will take time to show up in the data and the Fed will need concrete evidence of a slowdown before it cuts again.
Ironically, I think the tariffs increase the total number of cuts, it will just take longer to get started.
While inflation hovers over the Fed like a dark cloud, there are only two things that would lead to a cut in June.
- Financial system instability
- Job losses
Jobs
NFP was stale before it was released. And the last two months were revised down.
Plus, unusually warm weather distorted the data. The San Francisco Fed’s research suggests the weather boosted NFP by 150k-170k. In the graph below, the green bar is the headline number and the blue line is the weather-adjusted job gains.
More importantly unemployment is what the Fed will be watching. Just a few weeks ago, the FOMC SEP suggested a median estimate of 4.4% UR at year end…and Friday put us at 4.2%.
Neil Dutta pointed out that the employment/population ratio has contracted to levels normally only seen during recessions.
So where does this leave us? The job market hasn’t been as strong as reported, so the margin for error is less than we think. DOGE/hiring freezes will put an end to the biggest hiring component of the last 5 years. Uncertainty will pause hiring. Once it goes, it will go.
If we see unemployment climb, I expect the Fed to respond. Powell’s probably thinking, “OK, maybe the labor market can hang on this year while inflation runs up to 3.5%. Unemployment doesn’t start climbing until inflation has leveled off, and then we can cut.” Hope is a terrible hedge.
What if the job market remains strong? What if consumer spending doesn’t nose dive? What if GDP doesn’t crater? What if an extension of tax cuts and a big reduction in regulations translates into enough economic momentum that last week’s news ends up being a minor blip?
Those would be good outcomes. What if unemployment keeps climbing in the next 6 months while inflation is also climbing? The Fed will roll out the marketing machine to convince us inflation is transitory temporary, so they can cut rates to save jobs.
The Week Ahead
Tariffs and trade wars and CPI. Do I really need a Truth Social account now to stay on the leading edge of rate movements?
