May 1, 2025      

    While April showers may bring May flowers, they also brought unwelcome rain on the parade of the financial markets throughout April. The botanical prospects in the month ahead remain uncertain, while the reign of uncertainty in the financial markets appears ongoing. The administration's April 2^nd announcement of punitive tariff policies, which were much larger and more aggressive than anticipated, unleashed severe turbulence in the stock, bond and currency markets. The fluid nature of the trade policies since that announcement have only increased uncertainty and led the markets to price in the prospects of slower growth and higher inflation. 

     Economic growth is holding on, for now. To date, the 'hard’ data is looking at the economy through a rear-view mirror and is being treated by the financial markets as old news. Soft data, such as business and consumer confidence/sentiment surveys have fallen sharply and are expected to flow through to behavior and could result in a pullback in economic activity and further cooling in the labor market. The 1^st quarter GDP posted an annualized quarterly growth rate of -0.3% due to a record trade deficit as business front loaded goods imports ahead of tariffs. The year-over-year rate declined to 2% from 2.5% the previous quarter.

    Tariffs will weigh on the economy through a few channels. The inflation gauges for March cooled more than expected, but there are indicators that price pressures will be rising. For the Fed, rising inflation is troublesome. It could get more complicated as inflation expectations continue to rise, creating a self-reinforcing loop of greater price pressures. This may have been behind the better-than-expected March retail sales as consumers were thought to be front-running purchases of automobiles and building materials ahead of expected tariff based price hikes. Going forward, higher prices will cut consumers’ purchasing power, restraining real outlays. Consumer spending will slow as real income stagnates or even declines.    

     Manufacturing and services purchasing managers’ indexes (PMIs) and Federal Reserve District surveys are seeing a slowdown in hiring activity with sentiment weakening on trade uncertainty. The March employment report was healthy as labor markets remained calm up until the end of the first quarter. However, the PMIs, Fed surveys and a declining trend in job openings hints that labor demand is cooling, and concerns abound that trade policy uncertainty will further weigh on employment.

          For now, the Fed finds little option other than sitting and waiting for more clarity on both the policy and data front. As stated by Federal Reserve Chairman Jerome Powell in the last post-meeting press conference the Fed will try to separate “signal from noise” in seeking clarity. Going forward, the Fed will have to carefully weigh the risks of a slowing economy against the risks of inflation, and possible unhinging of inflation expectations as uncertainty swells around talk of trade, tariff and tax policies.

     For the Fed, caution is key in the face of uncertainty. The longer the uncertainty remains, the greater the probability that businesses will table hiring plans and consumers will tighten their belts. Both sides of the Fed’s dual mandate (stable prices and full employment) will be under pressure. Since the Fed cannot fight on both fronts at the same time, it appears resolved to wait for more clarity before adjusting monetary policy. Stuck between and a hard place, the Fed will likely find little choice but to hold rates steady at the May 6-7 FOMC meeting and promise to carefully weigh the risks to both sides of the dual mandate as it goes forward.