The Macro Backdrop

Certain Uncertainty

As the financial markets wrestle with the recent tariff announcements, one thing is still certain: uncertainty remains an integral part of the macroeconomic investment landscape. While we now know the actual tariff announcements, we don’t know what the results will look like in the weeks and months ahead. More importantly, we don’t know their potential impacts on the economy and inflation, not to mention Federal Reserve (Fed) policy decisions.

Against this backdrop, there’s been a debate about whether recently released data, such as the March jobs report, represents stale, i.e., pre-tariff, news. Yes, one can certainly make that case, but we would argue that it is also important to see how the economy/labor markets looked prior to Liberation Day, to assess whether they were sound enough to be able to absorb the potential negative effects that could be coming. One silver lining is that the March employment data revealed the labor market was still in relatively solid condition pre-tariffs.

At this juncture, we maintain as a base case that a recession can be avoided but fully acknowledge that the probabilities for an economic downturn have increased.

Inflation…A Bumpy Path

As we witnessed at the beginning of last year, inflation readings have revealed a “bumpy” setting to the start of 2025, but the March CPI report showed a return towards disinflation. Once again, the pre-tariff level of inflation is an important consideration, as investors try and determine where the trend stood as we prepare for what could lie ahead.

Indeed, the potential challenge going forward will be to see if the markets can look through any tariff-induced increases to inflation and focus instead on underlying demand pressures. In addition, as Fed Chair Powell recently stated, another key factor to consider is whether any potential increase in prices will be short-lived or have more of a persistent impact.

Either way, the Fed’s 2% target seems to lie further out on the horizon.

Fed Policy: Wait and See

According to Fed Chair Powell, the tariffs announced on April 2 were larger than expected, raising both downside risks to the economy and upside risks to inflation. Nevertheless, Powell continued to emphasize that it is too soon to say what the appropriate path should be for monetary policy. While the Fed appears to be still skewed toward rate cuts later this year, Powell acknowledged the economy and labor markets remain solid, providing the policy makers some cushion to “take a step back and let things clarify.”

Implied probabilities for Fed Funds Futures, as of this writing, are now tilted toward three rate cuts this year but, based upon past history, investors should take this with a grain of salt.

The Fed has in the recent past made a distinction between responding to economic/dual mandate-related issues and those that are related to market/funding. In the case of the latter, they turn to their balance sheet first, not rate cuts, which they would like to hold in abeyance to address the macroeconomic factors. As things stand now, a baseline of two rate cuts for this year seems to be a reasonable scenario.

“Chair Powell acknowledged the economy and labor markets remain solid, providing the policy makers some cushion to ‘take a step back and let things clarify’.”