US - Trump policy forces Fed to stay put

The US political and economic landscape has drastically changed since our last Monthly. Then, we had just seen the initial flurry of executive orders which dealt with, amongst others, immigration, inflation, reducing the government footprint and an unwinding of Biden policy. Before entering the oval office, Trump had already threatened substantial tariffs on Canada, Mexico and China which were set to be enacted on February 1st. Ultimately, only China faced a new 10% tariff, and the Canada and Mexico tariffs were postponed until March. These moves were all just the initial ascent on an unprecedented rollercoaster of US policy, with no braking zone in sight. Based on the number of executive orders, Trump is moving at more than four times the speed of Obama and Trump’s own first presidency, and double the speed of Biden, who had learnt from Trump’s late-term executive order antics.

The political implications of already enacted policies are large, and beyond the scope of this macro update. The economic implications of confirmed policy are relatively mild, for now. Policies on immigration and the federal workforce increases downside risks to the labour market, and put some mild pressure on inflation. The bigger economic impact is expected to come from tariffs, which are still surrounded by substantial uncertainty. The trade policy uncertainty index is at an all-time high, exceeding even the most uncertain times during the first Trump administration. In a recent note, we summarized the first month of tariff threats and quantified their potential impact. The Canada/Mexico tariff that is set to start next week has a substantial potential impact on all three economies, likely plunging Canada and maybe Mexico into a recession. The US gets a significant growth shock of around 0.9% spread over the year, and a shock to core PCE inflation of up to 0.7%. The design of the ‘reciprocal’ tariffs, which appears to replace the previous ‘universal’ tariff is still largely unknown, but the parameters outlined in the White House memorandum allow for a wide range of outcomes with no clear upper bound. Details of the reciprocal tariff plan are set to be revealed by April 2nd. The total package of proposals could lead to an increase in the trade weighted tariff of almost 20%, compared to a level of about 2.5% at the start of the Trump term, and far beyond our base-case assumption of an increase of about 8.5%. At the same time, backtracking and renegotiation shows that the magnitude of the ultimately implemented tariffs is highly uncertain.

While we wait for the impact of Trump’s policies to materialise, the underlying macro picture continues to evolve. GDP growth remained robust at 2.3% SAAR for 2024Q4, predominantly on the back of strong consumption. The January unemployment rate ticked down again to 4.0%, after a relatively solid jobs report. The big surprise came from January inflation which came in hotter than expected, with a headline CPI rate of 0.5% m/m, and core CPI also increasing by 0.4%. On the more positive side, PPI data suggests core PCE will come in at 0.3% m/m, and an update of seasonal adjustment factors made the last months of 2024 look marginally more benign. Still, disinflation has stalled, and while pressures from wages and shelter have largely subsided, the outlook compared to last month has moved towards increased upside risks stemming from both tariff and non-tariff pressures.

Considering the above, the prudent approach is for the Fed to stay put. Compared to the start of the easing cycle, the labour market looks better, and inflation risks tilted to the upside. Evolving fiscal policy is likely to have a bigger impact on the inflation rate than the unemployment rate, tilting the Fed towards a more restrictive stance in the future. Further easing in the near term would be risky. In light of the dual mandate, there appears to be no real benefit to easing at the current juncture, except to please Trump. Rather, easing risks a future U-turn, hurting credibility at a vulnerable time.