Markets Retreat as Fed Expects Inflation to Rise and Growth to Slow

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

Equities lost ground in a holiday-shortened week as investors continued to try to gauge the impact of a still fluid trade policy from the Trump administration. In recent weeks, we’ve highlighted the cloud of uncertainty that has weighed on the markets and shown up in surveys of consumers and businesses alike. The president suggested during a press conference late last week that some clarity may be coming, as a trade deal with China could be reached in weeks. He also noted that the administration had heard from 75 countries seeking to make trade deals since he unveiled his plans for reciprocal tariffs. However, details of the discussions were limited, and the president said that “we are in no rush” to reach a deal—instead saying that they would be reached at “some point.” As we wrote in last week’s commentary, despite the lack of clarity regarding negotiations, we believe the administration will reach agreements with some trading partners but expect that tariffs at some level will be a long-term piece of his overall plan to remake the global economy, including the role of the U.S. In the meantime, we believe uncertainty will continue to cause volatility in the markets, affect consumer behavior and likely cause businesses to take a more conservative approach as they struggle to forecast the impact of trade policies that don’t yet appear finalized.

Recent economic reports have failed to offer much clarity. Hard data, such as unemployment figures and the most recent Consumer Price Index reading, suggests a still solid economy showing some modest progress in the disinflation process. Conversely, soft data, including consumer and business surveys, shows concerns about a slowing economy and fears of rapidly rising inflation, which are affecting decision-making on purchases and hiring. Whether the soft data is a leading indicator that will eventually seep into hard data is unclear. While many of the surveys and leading indicators we follow have historically had a strong track record of forecasting where the economy is headed, they have proven less reliable since COVID. Indeed, throughout much of 2023 and part of 2024, soft data indicated the economy was either in or on the threshold of a recession that never materialized.

It may take months before the full impact of the Trump administration policies is clear. We believe the magnitude of the changes proposed are likely to add strain to an economy that was already in the late stages of a growth cycle. Given that tariffs are an additional cost to goods that will likely be borne to some degree by both consumers and businesses, we believe progress toward the Fed’s goal of bringing inflation down to 2 percent is likely to stall—and perhaps reverse—in the near term. The likely rise in prices may lead to slower economic growth. Our sentiment was shared by Chair Powell during his appearance at the Economic Club of Chicago last week. During his comments, Powell noted that solid hard data meant the Fed didn’t need to act preemptively to support the economy by cutting rates, but “the level of the tariff increases announced so far is significantly larger than anticipated. The same is likely to be true of the economic effects, which will include higher inflation and slower growth.” He went on to say that the combination of rising prices and slower growth will add tension to the Fed’s dual mandate of price stability and full employment: “Without price stability, we cannot achieve the long periods of strong labor market conditions that benefit all Americans.” In response to Powell’s assessment, President Trump said the Fed should be cutting rates to offset higher prices from tariffs and raised the possibility that Powell could be ousted, which has added to recent uncertainty.

The above discussion should not be viewed as an assessment of political policy nor as a prediction of a particular outcome. As we often note, the U.S. economy is too large and dynamic to precisely predict how things will play out. Instead, we are simply noting risks as we currently see them. And while risks may be elevated, we do not believe they call for dramatic changes to your investment plan. Instead, the current environment serves as a valuable reminder that an unpredictable future will lead to unpredictable opportunities for investors in the intermediate and long terms. And capitalizing on these unforeseen opportunities is best done through diversification.

Conversely, investors who sell during periods of volatility help to create opportunities for extra returns for those who stay true to their asset allocation. While we believe uncertainty will remain elevated for a while, we also believe the best way to address it is by focusing on the long term and staying diversified to avoid concentrating too much on any one market segment or asset class.

Wall Street wrap

Consumers buying ahead: The latest retail sales numbers from the U.S. Census Bureau show that consumer spending jumped last month, with overall retail and food service sales rising 1.4 percent in March. The rise was stronger than Wall Street expectations and marks a sharp rise from February’s growth of just 0.2 percent.

Growth was widespread, with 11 of 13 categories registering increases. Motor vehicle and part dealers saw the largest rise in sales, up 5.3 percent from the previous month. Overall retail sales are up 4.6 percent year over year on a seasonally adjusted basis. The strength of sales appears to be influenced by consumers buying ahead of expected price hikes that could come as a result of tariffs, reflected by the rise in vehicle purchases and a 3.3 percent increase in building materials and garden equipment sales. Overall, the Control Group (which is a proxy for the spending measure found in gross domestic product growth) was up a more muted 0.37 percent for the month, falling short of Wall Street expectations, and was down from the prior month’s growth of 1.3 percent.

Manufacturing production rises: Manufacturing output rose by 0.3 percent in March according to the latest data from the Federal Reserve. The increase was driven by a 0.6 percent rise in durable goods, with motor vehicle production up 1.2 percent, while aerospace and miscellaneous transportation equipment production were up 1.8 percent. Overall, industrial production fell 0.3 percent in March but was at a 5.5 percent annualized rate for the first quarter. The month-over-month decline was caused by a slowdown in utilities thanks to above-average temperatures throughout much of the country.

The rise in durable goods manufacturing may reflect companies trying to get ahead of tariffs and meet an uptick in demand by consumers concerned about rising prices. As we’ve detailed in recent weeks, recent surveys show a spike in consumers’ inflation expectations that have also influenced their views on the best time to make big-ticket purchases. Should consumers buy ahead of the expected implementation of reciprocal tariffs, it could lead to lower production numbers in the future.

Homebuilders’ confidence remains underwater: Homebuilder confidence was little changed in April as builders remain concerned about tariffs and higher construction costs. The latest reading from the National Association of Home Builders (NAHB) survey shows confidence came in at 40 in April, up one point from March but still at the low end of readings during the past eight months.

Modestly lower mortgage rates during the survey period boosted views of current conditions to 45, up two points from the prior month; however, sales expectations over the coming six months retreated four points from the prior month to 43. As optimism has faded in recent months, the portion of builders cutting prices has risen, with 29 percent of respondents reducing prices (up from 26 percent in February). The average price cut was 5 percent in March, unchanged from February.

While the ultimate rate of tariffs on imports of building materials has yet to be finalized, 60 percent of those surveyed said their suppliers have already raised prices or announced upcoming increases, with the average increase amounting to 6.3 percent. The NAHB estimates the increases will translate to it costing an additional $10,900 to build the average home.

The week ahead

Monday: The Conference Board’s latest Leading Economic Index Survey for March will be out mid-morning. Last month’s report showed some weakening in the near term, but the longer-term view suggests some headwinds for the economy. We will be scrutinizing the data to see if last month’s decline was a temporary setback.

Wednesday: We’ll get an update on the health of manufacturing and services in the U.S. when S&P Global releases its Flash Purchasing Manufacturers Index reports for April. Services showed growth last month, while manufacturing dipped back into contractionary territory. We will be watching to see if recent uncertainty from tariffs has had an impact on recent trends for both sectors.

The Federal Reserve will release data from its Beige Book. The book provides anecdotal insights into the nation’s economy, and last month’s report showed flat growth and rising prices. We will be watching to see if this trend continues.

The U.S. Census Bureau will release data on new home sales for March. We’ll be looking at this data to assess the impact lower mortgage rates in March had on demand for newly built homes.

Thursday: Data on durable goods orders for March will be released to start the day. We’ll be watching for signs of the direction of business spending in light of signs of growing uncertainty and slowing economic growth.

We’ll get additional insights into the housing market when the National Association of Realtors releases existing home sales for March. This report, along with the new homes data released earlier in the week, should give a clearer picture of whether the housing market is in a holding pattern due to elevated interest rates.

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