US Strategy Weekly: Tariff Tizzy

The first two weeks of Donald Trump’s presidency have been both hectic and head-spinning. And while some might call these past few days chaotic, the new administration has definitely been impactful, transparent, accessible, and game changing. And despite a tremendous amount of pearl-clutching by the media, the much-telegraphed tariffs on goods from Mexico, Canada, and China did not hurt the financial markets like most economists expected. To date, what has materialized are postponements due to potential political agreements with Mexico and Canada. The objectives here appear to be the monitoring of both borders to help prevent illegal immigration and the smuggling of illegal and lethal fentanyl.

Tariffs and deals with China may be more difficult to resolve in the near term, but China is also pivotal in terms of illegal fentanyl and that may be one of the longer-term goals. Meanwhile, economists and analysts are revising forecasts on future corporate earnings, inflation, and the economy based upon the administration’s actions, but if one is honest, no one knows how the tariffs will play out, even the negotiators. These tariffs are part of a process and Trump’s administration is currently working on a vast number of negotiations making outcomes extremely difficult to predict. Most importantly, one should not let personal political views color one’s forecast. In our view, it is important to analyze economic data skeptically and to make predictions objectively and separately from media headlines.

What is known is that Donald Trump used tariffs successfully in his first term and it did not impact inflation. What it did do was change American and global corporate behavior and as a result China lost manufacturing to other areas of Asia, such as Vietnam, Malaysia, and Cambodia. President Trump has been clear that this is another one of his goals and he is using the threat of tariffs as a catalyst to bring manufacturing back to the US. It is important to remember that inflation was 1.9% YOY when Trump left office and President Biden maintained Trump’s tariffs when he came to office.

This time it is different however because inflation is already a problem and service sector inflation has been sticky for several months. Farmers are facing rising feed stock costs, and this will trickle down into higher food prices. On the other hand, energy prices are expected to move lower. This could offset some of these threats and a higher dollar will also mute the potential impact of tariffs on imported goods. (But it will also be a handicap for exporters.)

What is also known is that President Trump takes pride in his pledge of “promises made, promises kept,” and this will be the cornerstone of his four years. To this end, the key financial-related promises are to increase energy production, increase jobs, reduce or eliminate government waste, lower taxes, and put the US in better fiscal shape. While not being specific, in our view, putting the US in better fiscal shape is apt to include a mixture of boosting economic activity and shrinking annual deficits. This combination would thereby lower the total public debt-to-GDP ratio which rose to 120% as of December 19, 2024 (https://fred.stlouisfed.org/series/gfdegdq188S). These are ambitious goals, but goals that are difficult to challenge.

The last week has also been hectic in terms of corporate earnings and economic releases. According to an S&P earnings scorecard, of the 211 companies in the S&P 500 that have reported earnings for the fourth quarter, 76.8% reported above analyst expectations. In general, earnings have helped boost equity prices.

Economic releases were mixed this week. In December, personal income grew 5.3% YOY, disposable income grew 5% YOY, and real personal disposable income (RPDI) grew 2.4%. RPDI fell from 2.6% in November and was below the long-term average of 3.2% for the tenth month in a row. See page 4. Government workers had the largest increase in wages in December with a gain of 6.5% YOY, and this pattern of government wages growing faster than private sector wages, has been ongoing since November 2022. Manufacturing workers had minimal increases in wages in the last six months of 2024. Meanwhile, government transfer payments and supplements to wages were robust in 2024. See page 5.

Personal consumption expenditures rose 5.7% YOY in December and service sector expenditures grew 6.7% YOY. In short, the growth in spending was greater than wage growth for most households, so it was not surprising that the savings rate fell from 4.3% to 4.1% at year end. Given this decline in household savings and the persistent rise in prices, household consumption could encounter headwinds in 2025. See page 6.

Average weekly earnings grew 3.5% in December, which was above the 2.9% YOY rate of inflation. However, this gap is narrowing since wage growth has been decelerating and inflation accelerating in recent reports. The PCE deflator rose from 2.4% in November to 2.6% in December and core PCE deflator was unchanged at 2.8% YOY. These figures were a disappointment to the consensus, and it has led to a consensus view that the Fed is unlikely to cut rates again in the near future. We agree. As previously noted, our concern is that farmers are currently seeing a rise in core feed stocks, and this will be a future driver of food prices at home and at restaurants. See page 7.

Hopefully, lower energy prices will offset higher food prices in 2025, however the bigger issue is that core inflation indices have been trending flat to higher. The core PCE deflator was unchanged at 2.8% in December. Core PPI was 2.6%, up from 2.5%, and up for the second month in a row. Core CPI was 3.2% in December, down from 3.3%, but has been stuck at 3.3% for three months in a row. This is why we do not expect rate cuts in the near future. Moreover, the real fed funds rate (fed funds minus the PCE deflator) is currently 180 basis points, down from 300 basis point in August. In our opinion, the Fed’s neutral rate is when the real fed funds rate is 200 to 300 basis points. See page 8.

The most favorable economic release of the week was the ISM manufacturing index for January. It was 50.9 and above 50 for the first time in 26 months! Seven of the ten components were higher in the month. Customers’ inventories were unchanged, and the inventories index and order backlog index were lower. The employment index rose to 50.3 and was above 50 for the first time in eight months. The best component was new orders, which increased from 52.1 to 55.1. See page 9. Since the DeepSeek controversy, technology stocks have underperformed, and this can be seen in the performance of the indices. The DJIA is up 4.7% year-to-date, the S&P 500 and the Russell 2000 are up 2.7%, and the Nasdaq Composite is up only 1.8%. Nevertheless, all the indices are in relatively stable and favorable uptrends. See page 12. Our 25-day volume oscillator remains neutral but has a bullish bias. In summary, we would be a buyer on dips.

Gail Dudack

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