Markets have been so overwhelmed by the tariffs issue that they have been ignoring key data recently. But if the fears around the trade war push the market beyond the fundamentals, at some point the market will have to recenter. This is why even amidst the turmoil, it’s still important to keep track of the data. In the end, whether the fear of a recession becomes a reality or not will be seen in the economic releases.
This week are two key data points from the US, namely the FOMC minutes and CPI figures. Both have become more important in the context of the tariff situation. The conventional wisdom is that tariffs will raise consumer prices, because they mean higher import costs. But the Fed will ultimately decide on what to do with the interest rate based on what shows up in the actual data.
A Shift in Narrative
A lot has changed about the market’s assumptions after last week’s tariff announcement, to be sure. Which is why the FOMC minutes are important now. At the last meeting, the Fed conveyed a general sentiment that the economy was solid, and there were inflationary pressures. The dot-plot matrix showed two rate cuts for this year, as the central bank worked on achieving that ‘soft landing’ that would keep the dollar relatively solid.
The members of the FOMC did point out that there was increased uncertainty because of the tariffs. Now that we have more details, investors are likely to look at the comments by Fed officials within the new context. The big worry is still that the US could enter a period of stagflation, with slow economic growth and high inflation. Figuring out what the Fed will do then depends on whether the emphasis is put on the economic situation or the price problem.
A New Outlook
As the market fell on Friday, participants moved to pricing in a small possibility of a rate cut as soon as the next meeting. But that hope quickly faded, and we’re back to expecting a rate cut at the June meeting. That implies the market thinks that inflation will be the primary issue. In fact, Fed Chair Jerome Powell said that tariffs will be inflationary, an implication that the Fed will be biased towards keeping rates elevated.
The thing is, of course, that a slower economy means inflation will underperform as well. And tariffs would likely have a one-off inflationary impact, like taxes typically do. Which means that even if there is a bump higher in CPI in the coming few months, that could reverse, leaving the Fed scrambling to cut later in the year. JPMorgan last week said it expected a recession in the second half, which would imply the Fed drastically cutting rates – and weakening the dollar.
But The Here and Now
However, the market still needs to react to the current situation, and the expectation is for inflationion to remain sticky. Which implies that the risk of something unexpected happening is to the downside. If inflation is more than expected, then the market might take it as confirmation, but will be more surprised with an undershoot.
The consensus is that March US inflation will come down to 2.5% from 2.8% prior, with the bulk of that being attributed to lower energy prices. That’s still above the Fed’s 2.0% target, indicating that even if it is moving in the right direction, it still has a ways to go. The core rate is expected to have a more modest improvement to 3.0% from 3.1% prior.
