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Written by: Steve Majoris | Advisor Asset Management
The start to 2025 has been filled with more market moving headlines than we have seen in some time. The new presidential administration has gone full throttle with tariffs, budget cuts and layoffs that have spooked investors and there is no shortage of questions as to what this means for the markets. Will the amount of Federal employee layoffs impact the state of the labor market? Will the budget cuts from federal agencies impact credit? Will tariffs lead us to a trade war and eventually a recession? There remains plenty of uncertainty with how things will play out, and if there’s one thing markets don’t like…it’s uncertainty. A risk-off tone has dominated markets over the past two months with spreads widening in credit, the S&P 500 selling off nearly 9% and Treasuries rallying over 2.65% on the year as money searches for a safe haven.
Those living in the D.C. metropolitan area are probably facing the most uncertainty, although warning signs have already emerged. Unemployment filings in D.C. have been on the rise as job cuts from Department of Government Efficiency (DOGE) take effect, and last month saw the largest weekly claims number since early 2023. In another indication of the strain, the median home price in D.C. has dropped by $139,000. The Trump administration has been adamant about wanting lower interest rates, and one likely reason is to get things in the housing market moving again. The latest housing market index reading from the National Association of Home Builders (NAHB) came in at 39 — the lowest level since August and not far off multi-year lows. In the municipal space, we are seeing spreads widen in D.C. and in nearby municipalities that have a large population of federal workers. Even looking outside of D.C., there have been budget cuts announced that are impacting individual municipal credits across the country, such as hospitals and higher education institutions.
This past Wednesday the Federal Open Market Committee (FOMC) mentioned in a statement following their interest rate decision: “Uncertainty around the economic outlook has increased.”
While uncertainty seems to be growing, consumer confidence appears to be shrinking. One of the more closely watched consumer sentiment numbers — one which the Fed keeps a close eye on — is the University of Michigan Consumer Sentiment Index. The sentiment index has fallen every reading so far this year. 2024 ended at 74.9, but since then we have had two consecutive misses to the downside with the latest at 57.9, the lowest since November 2022. In addition to headline misses, both releases included a pessimistic shift in the consumers views on inflation. The 1-year inflation expectation moved from 4.3% to 4.9% while the 5-year number moved from 3.3% to 3.9%. Concern over tariffs leading to higher prices likely played a role. These are probably not welcome signs for the Fed and Chairman Powell. Retail Sales for February was below expectations and included a downward revision for the previous month. There were, however, improvements in Ex Auto, Ex Auto and Gas and the Retail Sales Control Group number which came in at a solid 1%. When taking out food services, auto dealers, building materials and gas stations perhaps the consumer was stronger than expected in February.
On February 25 we got another rough sentiment number from the consumer with the release of Conference Board Consumer Confidence. The release was a 98.3 — much softer than the estimate of 102.50 — down sharply from the prior number and the lowest reading since April 2023. With a 1-year average at 103.49, 98.3 could be a cause for concern. The report mentioned:
“In February, consumer confidence registered the largest monthly decline since August 2021,” said Stephanie Guichard, Senior Economist, Global Indicators at The Conference Board. “This is the third consecutive month on month decline, bringing the Index to the bottom of the range that has prevailed since 2022. Of the five components of the Index, only consumers’ assessment of present business conditions improved, albeit slightly. Views of current labor market conditions weakened. Consumers became pessimistic about future business conditions and less optimistic about future income. Pessimism about future employment prospects worsened and reached a 10-month high.”
Similar to what we saw with the University of Michigan surveys, inflation expectations increased as well:
“Average 12-month inflation expectations surged from 5.2% to 6% in February. This increase likely reflected a mix of factors, including sticky inflation but also the recent jump in prices of key household staples like eggs and the expected impact of tariffs…. There was a sharp increase in the mentions of trade and tariffs, back to a level unseen since 2019. Most notably, comments on the current Administration and its policies dominated the responses.”
Not ideal for a Fed that is focused on getting inflation back to 2%.
The manufacturing sector does not look to be gaining much steam post-election either. There seems to be some hope that reshoring of factories and plants from multinational companies can improve trends but the latest reading from the Institute of Supply Management was a 50.3, up only slightly from the 1year average of 48.6. According to the report:
“U.S. manufacturing activity expanded marginally for the second month in a row in February after 26 consecutive months of contraction. Demand weakened, while output stabilized and inputs, for the first time in several months, contributed to PMI® growth. Indications that demand weakened include: the (1) New Orders Index dropped into contraction territory, (2) New Export Orders Index continued expanding, but at a slower rate, (3) Backlog of Orders Index continued in contraction, but moved upward, and (4) Customers’ Inventories Index moved further into ‘too low’ territory.”
There were also specific mentions of tariffs and job cuts, currently, two of the main concerns for markets.
“Demand eased, production stabilized, and de-staffing continued as panelists’ companies experience the first operational shock of the new administration’s tariff policy. Prices growth accelerated due to tariffs, causing new order placement backlogs, supplier delivery stoppages and manufacturing inventory impacts.”
It may be just a matter of time till the Fed needs to start worrying about the other part of their dual mandate, full employment.
It has been a rocky start to the year on the economic data front. Enough for investors to question whether a slowdown is in the cards. A few things to remember as the 2025 rollercoaster continues. Tariff headlines out of Washington will likely continue but perhaps have less of an impact on volatility moving forward. There is a fair argument that markets are pricing in risk that has always existed which could be considered a healthy correction. We can all acknowledge the market has felt like a whipsaw as of late, but time IN the market is likely a larger driver of total returns than timING the market. Long-term returns are not derailed by short-term movements and sticking to your investing strategy and not making changes on a whim chasing the latest headline could be prudent in our view. President Trump has always used tariffs as a negotiating tool, which means that new trade deals could emerge as a result. There is a chance that rhetoric will ease, and uncertainty will dissipate, but only time will tell. We have had growth scares before, there is no guarantee they lead to a recession. Bond market indicators like the slope of the yield curve have not raised any alarm bells for investors yet. A focus on income may be a favorable approach, especially if one believes volatility will continue. This will be a tricky environment with credit as we’ve already seen widening in specific areas and downstream affects from budget cuts will likely remain a risk. Privately managed accounts or an active approach may help investors sleep better at night knowing there is a lighthouse helping keep their ships off rocky shoals.
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