Policy uncertainty Policy uncertainty http://www.federatedinvestors.com/texPool/static/images/texpool/texpool-logo-amp.png http://www.federatedinvestors.com/texPool/daf\images\insights\article\white-house-lawn-small.jpg February 27 2025 February 28 2025

Policy uncertainty

Financial markets roiled by developments in D.C.
Published February 28 2025

Bottom Line

The surge in election-related optimism investors enjoyed last summer and autumn has faded, replaced by uncertainty surrounding the implementation and impact of Trump’s ambitious fiscal policy plans: immigration reform, tariffs, deregulation, increased energy exploration/production, corporate and individual tax cuts, DOGE and geopolitics, among many others. Financial markets have been on edge, as investors are not sure what will ultimately stick. 

Trade and tariff war? The US trade deficit hit a record $1.2 trillion in 2024. China accounted for nearly a quarter of that amount, with Mexico second at more than 14%. The advance goods trade balance deficit for January 2025 rose nearly 26% month-over-month (m/m) to a higher-than-expected $153 billion, driven by a 12% increase in imports of $325 billion. Both figures are record highs. 

Not a surprise, then, that the administration has threatened to increase tariffs, looking to level the playing field, raise additional revenue, encourage more onshoring and extract favorable terms or  non-economic concessions from our trade partners. Many US companies have been importing more goods than usual over the past several months, expecting prices to rise. This worsening trade balance will lower GDP. As a result, the Atlanta Fed’s GDPNow estimate for the first quarter of 2025 plunged from 3.9% in early February to -1.5% today. 

Business and consumer confidence have rolled over: 

  • NFIB Small Business Optimism Index rose from an 11-year low of 88.5 in March 2024 to a six-year high of 105.1 in December, before slipping to 102.8 in January 2025. 
  • University of Michigan Consumer Sentiment Index soared from an eight-month low of 66.4 in July 2024 to an eight-month high of 74.0 in December, before declining to a 16-month low of 64.7 in February 2025.
  • Conference Board’s Consumer Confidence Index rose from a two-year low of 97.8 in June 2024 to a 16-month high of 112.8 in November, before falling to an eight-month low of 98.3 in February 2025.

Progress the Fed has made on cooling stubborn inflation in 2023 has stalled: 

  • Core PPI wholesale inflation has re-accelerated, doubling from 1.8% year-over-year (y/y) growth in December 2023 to 3.6% in January 2025. 
  • Core CPI retail inflation has declined from 3.9% y/y in December 2023, but it has stalled at 3.2-3.3% over each of the past eight months through January 2025. 
  • Core PCE inflation (the Fed’s preferred measure) declined from its peak of 3.0% in December 2023, but it has stalled at 2.6-2.9% y/y over the past nine months through January 2025, still well above the Fed’s 2% target.

Strong holiday spending has slowed Retail sales during Christmas rose a stronger-than-expected 3.9% y/y, versus a weak 2.7% last year. The National Retail Federation was projecting Christmas sales growth of 2.5-3.5%. While a soaring wealth effect fueled solid Christmas spending, driven by high-end consumption that offset weaker low-end demand, consumers across the board have pulled in their horns during January, and perhaps February.

Despite the frigid weather and devastating Los Angeles wildfires that kept many consumers from visiting brick-and-mortar stores in January, online shopping also plunged 1.9% m/m, its worst one-month decline since 2021. That suggests the recent re-acceleration in inflation and decline in consumer confidence, Trump’s tariff threats, the slimmest Social Security inflation adjustment in four years at 2.5% and the lowest savings rate at 3.5% in two years in December (which leapt to 4.6% in January) may have combined to pressure post-holiday spending.

Shot across the bow? The labor market has rebounded strongly over the last several months, but this week’s spike in initial weekly jobless claims to a four-month high of 242,000 raised an eyebrow. Some of this might be attributed to the layoffs demanded by DOGE, chaired by Elon Musk.

Slower pace of Federal Reserve rate cuts All of this creates some uncertainty as to the Fed’s rate- cutting plans. We now expect one or two data-dependent, quarter-point rate cuts in the second half of this year, once policymakers get a better sense of Trump’s fiscal policies, and their impact on the labor market and inflation.

Mixed markets As a result of this uncertainty, bonds have rallied and stocks have corrected in recent weeks. Equity enthusiasm prevailed from early August into mid-February, as the S&P 500 soared by 20% over that six-month period to a record high of 6,147. But over the past fortnight, stocks have corrected 5%. Spooked by the fiscal policy shifts, the bond vigilantes pushed benchmark 10-year Treasury yields up from 3.6% in mid-September to 4.80% in mid-January. But over the past six weeks, as it appeared that the economy was slowing, Treasuries rallied hard, with yields falling to an overbought 4.2% today.

Tweaking our forecasts The fixed-income, liquidity and equity investment professionals who comprise Federated Hermes’s macroeconomic policy committee met last Wednesday to discuss policy developments. The Commerce Department left fourth quarter 2024 GDP growth at 2.3%, compared with stronger gains of 3.1% and 3.0% in last year’s third and second quarters, respectively. 

  • We reduced our estimate for first quarter 2025 GDP growth from 2.4% to 2.3%, as consumer spending in January was very weak. The Blue-Chip consensus raised its estimate from 2.1% to 2.2% (within a range of 1.6% to 2.6%), while the Atlanta Fed’s GDPNow reduced its estimate from 3.9% to -1.5%, due to the decline in consumer spending and the widening trade deficit.
  • We lowered our estimate for second quarter 2025 GDP growth from 2.4% to 2.3%, while the Blue-Chip consensus left its estimate unchanged at 1.9% (within a range of 1.4% to 2.5%).
  • We left our estimate for third quarter 2025 GDP growth unchanged at 2.4%, while the Blue-Chip left its estimate unchanged at 1.9% (within a range of 1.2% to 2.4%).
  • We left our estimate for fourth quarter 2025 GDP growth unchanged at 2.5%, while the Blue-Chip consensus also left its estimate unchanged at 1.9% (within a range of 1.2% to 2.4%).
  • That leaves our full-year 2025 GDP growth estimate unchanged at 2.5%, while the Blue-Chip consensus also kept its estimate unchanged at 2.2% (within a range of 1.9% to 2.5%). 
  • We raised our year-end 2025 forecast for core CPI inflation from 2.7% to 2.8% (compared with actual core inflation of 3.3% in January 2025), while the Blue Chip raised its estimate from 2.5% to 2.7% (within a range of 2.4% to 3.0%). We also raised our year-end 2025 estimate for core PCE inflation from 2.4% to 2.5% (compared with actual core inflation of 2.6% in January 2025), while the Blue-Chip consensus raised its estimate from 2.3% to 2.4% (within a range of 2.1% to 2.7%).
  • Based upon the full-year economic impact we expect from Trump’s fiscal policy initiatives during 2025, we left our estimate for full-year 2026 GDP growth unchanged at 2.9%, while the Blue Chip also left its estimate unchanged at 2.0% (within a range of 1.4% to 2.4%). 
  • We left our year-end 2026 estimate for core CPI inflation unchanged at 2.5%, while the Blue Chip also left its forecast unchanged at 2.6% (within a wide range of 2.2% to 3.2%). We left our year-end 2026 estimate unchanged for core PCE inflation at 2.3%, while the Blue Chip also left its estimate unchanged at 2.4% (within a range of 2.0% to 3.0%).

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DISCLOSURES

Views are as of the date above and are subject to change based on market conditions and other factors. These views should not be construed as a recommendation for any specific security or sector.

The Conference Board's Consumer Confidence Index measures how optimistic or pessimistic consumers are about the economy.

Consumer Price Index (CPI): A measure of inflation at the retail level.

The National Federation of Independent Business (NFIB) conducts surveys monthly to gauge how small businesses feel about the economy, their situation and their plans.

Personal Consumption Expenditures Price Index (PCE): A measure of inflation at the consumer level.

Producer Price Index (PPI): A measure of inflation at the wholesale level.

S&P 500 Index: An unmanaged capitalization-weighted index of 500 stocks designated to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indexes are unmanaged and investments cannot be made in an index.

The University of Michigan Consumer Sentiment Index is a measure of consumer confidence based on a monthly telephone survey by the University of Michigan that gathers information on consumer expectations regarding the overall economy.

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