Payden & Rygel: Where do things stand?
A whirlwind month for markets in April and a data deluge last week brought the S&P 500 back above where it started on April 2nd. Where do things stand?
With a deluge of data in the last week and a Fed meeting in the days ahead, it’s a good time to “take stock.” In short, we have good news, bad news, and good news to report.
The good news is that the economy was doing just fine heading into 2025.
U.S. GDP recorded ten quarters of above-trend growth leading up to 2025. The unemployment rate was stable at around 4% for 12 months, and core inflation was cooling off.
With that backdrop, it makes sense to initiate a once-in-50-years dramatic shift in trade policy (we’re kidding).
We haven’t seen such a shocking shift in international finance and trade since Nixon’s historic closure of the gold window in August 1971. Case in point: the U.S. effective tariff rate in 2025 (~12%, our best guess at this juncture) would be 10 full percentage points higher than the effective tariff rate in the last 30 years (~2%).
It’s bad news because tariffs act as a tax on U.S. consumers and businesses (importers of goods for domestic production and export), and ongoing trade negotiations serve as an overall “uncertainty tax” on the economy (evidence for this is the collapse of “soft” survey data). As a result, we anticipate slower GDP growth this year (1% Q4/Q4 GDP growth versus our 2% call to start the year).
The Bloomberg consensus has similarly ratcheted down its growth expectations for the year. However, there are too many overly bearish takes out there, and the likelihood of a “sub-par” growth scenario unfolding in 2025 still outweighs the “recession” scenario, in our view.
Last week’s economic data lends credence to the idea that the U.S. economy may be resilient enough to withstand a trade shock and avoid a downturn.
First, while headline GDP was negative in the first quarter of 2025 (-0.3%), real private domestic final purchases, PDFP, a “core GDP” metric that excludes volatility from trade, inventories, and government spending, rose at a 3% clip in Q1! A nice plot of PDFP versus real GDP was our Chart of the Week last week. Interestingly, PDFP suggests that a sharp slowdown in GDP may be avoided, as a solid PDFP print usually precedes robust average GDP growth in the next four quarters 86% of the time since 1980.
Second, the tariff shock’s ripple effects are evident in Q1 GDP data. Imports surged in Q1 due to tariff fears as producers tried to “front-run” by importing more goods before tariff rates were officially levied. And, since GDP calculations remove imported goods to isolate domestic output (remember, GDP = gross domestic product), net trade sliced nearly five percentage points off headline GDP—the single biggest quarterly drag since 1947! However, the drag could be reversed or lessened in Q2 as imports subside.
Third, many (most?) investors fail to appreciate the intricate nature of global supply chains. Tariffs, particularly severe on one country (e.g., China), do not represent an embargo on goods. A more comprehensive version of global containership activity shows the activity has not collapsed as some have feared.
Fourth, the April jobs data still shows an economy adding jobs at a more than sufficient pace to keep the unemployment rate near 4%. The government conducted the April jobs surveys in early April, so the full effect of tariffs and trade uncertainty may not have been felt yet. That said, the jobs report is the best economic data report that is close to “real-time.” While tariff uncertainty has weighed on the soft data since February 2nd, the economy continues adding jobs.
Fed policymakers also put particular emphasis on PDFP and NFP (payrolls). Since both figures still show a growing economy, the Fed will likely stand pat at this week’s FOMC meeting. Remember, the FOMC is tasked with a dual mandate, and for now, the deviation of its inflation target outweighs deviations from full employment (core inflation is 0.5 percentage points above the 2% inflation target, and the unemployment rate is just 0.1 percentage points above the natural rate of unemployment).
Nonetheless, the next move from the Fed will likely be a cut, but the Fed will need more evidence of the deteriorating labor market first. We anticipate more cooling in the labor market as the year progresses, but the Fed might delay cuts until after summer. While delayed, the Fed could cut more quickly (50 bps cuts instead of 25 bps).
It’s also worth noting that we’ve seen, as recently as last summer, a Fed willing to pivot quickly to cuts if the labor market shows worrisome signs (the unemployment rate had jumped from 3.9% to 4.3% over five months, and the Fed went 50 in September 2024, even though Trimmed Mean PCE at the time was above target at 2.66%).
The bottom line is that financial markets likely overreacted to April 2nd’s announcement and the poor policy communication chaos in ensuing weeks, but the worst-case “sudden stop” economic prognostications don’t seem to be playing out (at least not yet), and stocks and bonds have recovered as a result, which makes sense to us.
The macro “truth” is always somewhere between the extreme bearish and bullish takes that often dominate the punditry class.
