Happy Liberation Day! Wednesday brings a fresh round of tariffs, which the Fed’s Bostic says will have an “inevitable” impact on inflation.
Bloomberg’s Ana Wong expects Core PCE to rise 0.5% this year, which would push it to 3.3%. “According to model-based estimates used by the Federal Reserve Board during Trump’s first term, that 28 ppt increase in tariffs could translate to a 4.0% hit to US GDP and add close to 2.5% to core PCE, a shock that we think would play out over a two to three year period.”
That would translate into GDP of -1.6% and Core PCE of 5.3%.If that’s liberation, sign me up for captivity! “Ummmm…I was told there would be tax cuts and less regulation…”
Last Week This Morning
- 10T: 4.25%
- 2T: 3.91%
- SOFR: 4.36%
- Term SOFR: 4.32%
- GDP: 2.4% actual vs 2.3% expected
- Personal Spending: 0.4% actual vs 0.5% expected
- Personal Income: 0.8% actual vs 0.4% expected
- Core PCE m/m: 0.4% actual vs 0.3% expected
- Core PCE y/y: 2.8% actual vs 2.7% expected
Consumer Spending
Inflation came out hotter than expected and rates dropped?
The Consumer Spending data came in much weaker than expected. Since consumer spending is 2/3rds of GDP, it flows directly through. The Atlanta Fed’s GDPNow was +0.5% before the release and -0.5% after.
Half of all consumer spending is from the top 5% of income earners. Any changes to their spending habits disproportionately impacts the overall consumer spending numbers. Who do you think is most impacted by a stock market sell off? Probably the same group Googling “Fed Put.”
Moody’s Mark Zandi, “Consumer confidence as measured by the Conference Board is down 17 points over the past 3 months. Remember my #1 recession watch indicator is that if confidence falls by 20 points over 3 months, consumers stop spending and recession ensues about 6 months later. This indicator isn’t flashing recession red, but it is flashing a bright yellow. The good news is that it is tariffs and other economic policies that have consumers spooked. These policies can be changed and confidence would recover. Recession avoided. The bad news is that this shift in policy course has to happen soon.”
The longer the Uncertainty Bends™ drags on, the more likely we are to enter a recession. Right now, sentiment seems to be more correlated to headlines rather than reality, but it could become a self-fulfilling prophecy. Oh, and one more warm and fuzzy for you…
The average length of time between the yield curve uninverting and the start of a recession is 7 months. The yield curve uninverted in August. Even Texas Tony Longhorn can figure out how many months that is…
Jobs
The Uncertainty Bends™ is a major contributor to plunging consumer sentiment, but so are softening job prospects.
Friday’s jobs report is maybe the biggest one I can remember since covid. Consensus forecast is for 138k (after last month’s 151k), but some of January and February’s weakness was attributed to bad weather. If that’s true, we might see some of that get paid back.
Dr. Guy Berger, Director of Economic Research at the Burning Glass Institute, “Future employment plans rose after the 2024 election. However, in the past 6 weeks, that euphoria has completely evaporated - firms are actually more downbeat about their future headcount than they were before the election.” In his graph below, the blue line is companies expecting to increase headcount while the orange is companies expecting to decrease headcount.
The Unemployment Rate is forecasted at 4.1%, but we only missed a 4.2% last month from a tiny rounding factor. I know that’s a historically strong starting point, but I think it’s important to note the impact of covid on the participation rate. If we used the participation rate from February 2020, the Unemployment Rate would be 5.5%. I grew up with 5% being “full employment” and I think 4% is the new 5%. If that’s true, it suggests the margin for error is much smaller than the Fed might believe.
With the threat of tariffs forcing the Fed to remain focused on inflation, I think they will be on hold for longer than they would otherwise be. I don’t know what the labor market tipping point is, but the Fed may tolerate a weaker job market than I previously thought.
We might be headed for a Trump vs Powell showdown. Who blinks first? I think Trump. He’s a deal junkie and I expect the ultimate tariffs to be smaller than the headlines.
Rates
Recall that opening Bloomberg quote, “According to model-based estimates used by the Federal Reserve Board during Trump’s first term, that 28 ppt increase in tariffs could translate to a 4% hit to US GDP and add close to 2.5% to core PCE, a shock that we think would play out over a two to three year period.”
Many of our clients have begun considering ways to hedge term to get them on the other side of this uncertainty. Cap costs are dramatically cheaper than a year ago. Rather than solving for the cost, however, we’ve had an increase in clients solving for term. “Here’s what I want to spend, how much time does that buy me?”
If you have $375k to spend on a $50mm cap and set the strike at current floating rate levels of 4.33%, you can get 36 months of protection. That ensures your rate can’t increase until the 2028 Olympics!
A year ago, $375k would have only bought 10 months of protection at that strike.
What if you just want to get through the 2026 midterms?
Instead of $375k, you’d spend $125k (0.15% of notional).
I still think the odds of the wheels falling off are increasing with each passing day. If we’re still dealing with the Uncertainty Bends™ three months from now, expectations will become reality and the Fed will ultimately cut even more than I expected at the start of the year. The threat of tariffs will keep them on hold for longer than usual, only exacerbating the ultimate pain.
Worse yet, will they hike? Only if they believe the current level of rates becomes accommodative, aka pressing on the gas pedal. That would require that inflation is/expected to be higher than 4.5%.
If I accidentally get added to an FOMC Signal chat about the Fed’s plans, please know two things:
- It is NOT a security breach
- I will 100% tell you what the Fed is planning on doing
The Week Ahead
Tariff talk and Friday’s labor report are all that matter.
