Federal Reserve is in No Hurry to Act on Rates Amid Trade Uncertainty

Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.

Concerns about tariffs cooled somewhat last week after the U.S. announced it had reached agreement on a framework for a trade deal with the United Kingdom and President Trump indicated he was open to cutting tariffs on imports from China to 80 percent from their current level of 145 percent. The announcement preceded trade talks over the weekend that resulted in a temporary reduction with the U.S. reducing the tariff rate on goods from China to 30 percent and China reducing its levies on U.S. goods to 10 percent. Because the U.S. runs a trade surplus with the UK, the framework appears to offer limited insights into how future agreements may look with larger trading partners and those with which the U.S. has a significant trading deficit. However, given that the UK deal includes a baseline of 10 percent on all imports into the U.S. from the UK, it is likely that the 10 percent minimum levy will remain in all trade deals going forward. Similarly, the temporary deal with China is a welcomed development but we believe negotiations could still result in unexpected twists and turns along the way. As with the UK deal, we expect any final agreement with China will include a baseline tariff of between 10 and 15 percent which will still be higher than in the past 80 years. We believe the baseline tariffs will have nearer-term impacts on inflation and growth in the U.S.

Last week’s developments added to cautious optimism lurking over the past few weeks among some investors that that the Trump administration will soften its approach to trade and as a result will reduce the likelihood of a recession. To be sure, investor sentiment has followed the same trajectory of consumers and businesses as captured in various surveys or so-called soft data. The latest reading of the American Association of Individual Investors (AAII) sentiment survey shows that 29.4 percent of those surveyed have a bullish view on the direction of the market for the coming six months. For context, the historical average of those with a bullish view is 37.5 percent.

While investors have a generally bearish take on where markets are headed, sentiment has rebounded significantly from where it was when the first wave of tariffs against Canada, Mexico and China were announced in February of this year. After a flurry of announcements on country-specific tariffs as well as levies on steel and aluminum imports, investor sentiment tumbled, hitting a low of 19.1 percent for the week ending March 12. Since then, sentiment has moved in response to news and speculation about the possible endgame for the administration's trade policies. Recent hopes of growing momentum in trade negotiations helped drive investor optimism to 29.4 percent, which marks the highest reading since the first week of February. It’s worth noting that the reading is based on survey responses that came before the announcement of the UK trade deal as well as Trump’s softened stance on the level of duties for goods from China.

As we noted in our commentary last week, while we recognize it is possible that trade deals could be struck that will reduce the level of tariffs placed on imports from the levels announced initially, we continue to believe that the administration is determined to apply levies as part of its efforts to reorient the global economy and the role of the U.S. in it. Put simply, we believe uncertainty will continue as the administration continues to negotiate trade deals on a country-by-country basis. Our view was echoed by Federal Reserve Chair Jerome Powell in his press conference following last week’s Federal Open Markets Committee (FOMC) meeting. As expected, the FOMC left rates unchanged at its latest meeting, with Powell noting that although soft data has deteriorated, hard data shows the economy is still solid. The chair went on to note that given the resiliency of the hard data and the dynamic nature of trade negotiations, it is unlikely the Fed would be willing to preemptively cut rates in anticipation of the impact of levies. “The scope, the scale, the persistence of those effects are very, very uncertain, so it’s not at all clear what the appropriate response for monetary policy is at this time. It’s really not at all clear what it is we should be doing. I don’t think we can say which way this will shake out,” Powell said.

In some respects, the challenges the Fed faces are the same as those it has grappled with for the past two years—how to keep the economy growing, which would result in maximum employment while still making progress on bringing inflation back to its stated goal of 2 percent. However, the expected impact of tariffs has significantly complicated the challenge. As Powell noted, the Fed believes risks to both sides of its dual mandate of price stability and maximum employment have risen since the initial wave of tariffs were announced. If, as is widely expected, tariffs lead to slowing growth, higher prices and a rise in unemployment, the Fed will be forced to decide whether the job market or rising prices are a greater threat to its dual mandate. As such, it is unlikely the Fed will move until much of the uncertainty has cleared. The upshot of this reality is that even as trade deals are announced in the future, the ultimate impact and the Fed’s response may not be known for an extended period.

The market volatility in response to trade headlines and tariff adjustments offers a cautionary example of the near-impossible task investors face when trying to time the market. This is why we encourage you to work with your advisor to ensure your investment plan is aligned with your risk tolerance and stick to your plan. We are in the midst of a shifting economic backdrop and as we detailed in our recent Quarterly Commentary, this change is likely to result in a new set of performance winners. Capitalizing on these unforeseen opportunities is best done through diversification.

Wall Street wrap

Last week was a lighter week for data, with the primary report focused on the services sector. This week will provide insights into whether recent soft data has begun to seep into hard data as we get the latest Consumer Price Index (CPI) and Producer Price Index (PPI) as well as retail sales and industrial production.

Modest growth for the services sector: The latest data from the Institute for Supply Management showed the services sector continuing to expand at a modest pace in April with a headline reading of 51.6 (readings below 50 signal expansion), up from March’s final reading of 50.8. However, strength narrowed during the month, with 11 of 18 industries reporting growth, up slightly from 10 of 18 in March. New orders rose to 52.3, up from the prior month’s reading of 50.4. Prices jumped, with the latest reading coming in at 65.1, up from 60.9 in March. The latest figure marks the fifth consecutive month that the input price index has been above 60 percent. The price index is now at the highest level since January 2023. Increased price pressures were widespread, with 17 of 18 industries reporting higher costs. Arts, entertainment and recreation was the only industry to report a decline in input costs.

The latest results from the survey showed the employment index rose to 49, up 2.8 points from March’s final reading but still in contraction. Eight of 18 industries reported growth in employment, while eight recorded declines in payrolls; the remaining two saw little or no change in hiring.

The week ahead

Tuesday: The CPI report from the Bureau of Labor Statistics (BLS) will be the big report for the week. Last month’s data showed that core inflation eased. We will be digging into the data to see if last month’s slower pace continued or if reports of higher costs for some businesses, which have been reported in recent survey data, have translated to higher prices for consumers.

The National Federation of Independent Businesses Small Business Optimism Index readings for April will be out before the opening bell. Last month’s report showed companies’ profit margins continuing to shrink as costs rise, and sales remain weak. We will watch to see if the fluid nature of tariff discussions continues to sow concerns among business owners.

Thursday: The U.S. Census Bureau will release the latest numbers on retail sales for April before the opening bell. Last month’s report showed strong growth in sales, which may reflect consumers buying ahead of expected tariffs. We will be watching to see if consumers are continuing to spend even as tariffs have mostly been put on hold.

The Federal Reserve will release April data on industrial production and capacity utilization. Production declined last month, and we will be watching to see whether survey data suggesting a slowdown in economic activity is beginning to show up in this hard data report.

The latest readings from the BLS on its Producer Price Index will offer a look at changes in costs for buyers of finished goods for March. We will be watching to see if input costs continue to creep higher, which could put pressure on profit margins or slow the pace of disinflation.

The Homebuilders Index from the National Association of Home Builders will be out in the morning. Confidence among builders remained subdued last month due to concerns about tariffs and building costs.

Initial and continuing jobless claims will be out before the market opens. Continuing claims have been trending higher, and we’ll continue to monitor this report for further signs of eroding strength of the employment picture.

Friday: The University of Michigan will release its preliminary report on May consumer sentiment and inflation expectations. Consumer sentiment has tumbled in recent months as inflation expectations have turned higher in response to concerns about tariffs. We will be watching to see if the trend continues or if there are signs that those concerns are having an effect on attitudes toward purchases in the months ahead.

We’ll get April starts and building permits from the U.S. Census Bureau. This data, along with the Homebuilders Index released on Thursday, will provide insight into the home construction market.

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